ifce eng v4 march 2012

Learning Objective:‘To introduce candidates to the need for insurance, the principles of insurance and the legal framework that underpin its practice.’

002

Principles and Practices of Insurance

ForewordImproving knowledge, developing skills, building careersThe insurance industry in the Kingdom has arrived.

The success of the new industry will rely on the knowledge and skills of the people who work in the industry.

Professionalism in insurance is not an option but is a must.

As a first step in the development of Saudi Arabian insurance professionals, the Institute of Banking has developed this foundation course in insurance which must be taken before all other courses.

The Foundation Course has been formed with individual modules covering different subject areas within insurance, protection and savings. During your studies, your principal learning resource will be yourself and this courseware. However, the Institute of Banking has also developed a classroom based presentation to accompany and support this book.

The instructor of this program will guide your studies, develop your group discussions and be able to fully explain those issues which are particularly complex. He will also answer your questions on specific issues that you may find difficult.

There are three knowledge ratings used throughout the course which indicate the depth of knowledge required for each topic. These are i. To be aware of, ii. To have knowledge of and iii. To understand.

The courseware contains definitions and explanations throughout together with regular short questions to check your understanding of the text. These questions are given in a box and will either test your understanding of the topic or stimulate your thought process and facilitate further discussion.

At the end of each module, there is a series of questions to test your knowledge of the module. It is strongly recommended that these be completed before moving on to the next module.

The IOB’s goal of developing excellence amongst insurance professionals in the Kingdom will only be achieved if each of us strives for insurance knowledge. This program is here for your development. Use it!

Good luck, enjoy the Program and, may it be the stepping-stone to an interesting and rewarding career.

IconsWhen you read the print materials, you will find the following icons displayed in the left hand margin.Indicates key content to which you should pay special attention.Notes a website that may contain additional information on a topic.Directs you to other modules that contains more information on a topic. Questions to test your understanding of the topic and/or for further discussion.

003


Module 1: Risk and Insurance 1.1 Meaning of risk 0071.2 Categories of risk 0081.3 Insurable risks 0121.4 Uninsurable risks 0131.5 Insurance as a risk transfer mechanism 0151.6 Pooling of risk 0161.7 Perils and hazards 0191.8 Benefits of insurance 0211.9 Reinsurance 0251.10 Co-insurance and self-insurance 0301.11 How an insurance company operates 032Progress Check 035

Module 2: Legal Principles of Insurance 2.1 Utmost Good Faith 041 2.2 Insurable Interest 0442.3 Indemnity 0462.4 Subrogation 0532.5 Contribution 0552.6 Proximate Cause 058Progress Check 061

Module 3: Risk Underwriting3.1 Material facts 0673.2 Physical and moral hazards and the use of warranties 0693.3 Proposal forms and broker’s slips 0743.4 Surveys 0783.5 Quotations 080Progress Check 084

Module 4: The Insurance Market4.1 Components of the insurance market 0894.2 Intermediaries 092 4.3 Distribution channels 0954.4 The role of ancillary players in the insurance 097Progress Check 100

Module 5: The need for documentation5.1 Proposal Forms and policy structure 1055.2 Warranties and endorsements 1095.3 Cover notes and certificates of insurance 1105.4 Claim forms 1125.5 Renewal invitations 114Progress Check 116

Module 6: Regulation of the Insurance Industry in the Kingdom6.1 Why the insurance and protection/savings industry needs to be regulated. 1216.2 The Historical Background of the Insurance Industry in the Kingdom 1236.3 Regulation of insurance in the Kingdom of Saudi Arabia 127Progress Check 148

Module 7: Market Code of Conduct Regulation MCCR7.1 Introduction 1537.2 General Requirements 1547.3 Standards of Practice 1567.4 Appendix 163

Progress Check Answers 182

Course Content & Syllabus:

Module 1:Risk and Insurance

After studying this module, you should be able to:

- List the main components of risk- Demonstrate how insurance relates to risk- Identify the categories of risk- Compare insurable and uninsurable interest- Describe the relation between frequency and severity- Distinguish between perils and hazards- Describe how insurance operates as a risk transfer mechanism- Describe how the common pool operates- Identify the benefits of insurance to individuals, business and economy- Understand co-insurance and self insurance

006 007

IntroductionThe first module introduces the student to the broad principles that govern how insurance operates. Risk and insurance are linked and this module provides a greater understanding of the meaning of risk both in its ordinary meaning and how it relates to insurance and which risks are insurable. We examine how insurance operates to transfer risks through the principal concept of the ‘Losses of the few, shared by the many’. Perils and hazards, two key aspects of insurance work are distinguished.

Following our examination of risk and insurance and the broad concepts that enable insurance to operate, we then look at why consumers buy insurance and the additional benefits that arise from its basic function. We also look at why insurers themselves need to insure and the relationship between the original insured, their insurer and the insurer of the insurance company.

Finally, we look at other options available to insurers when arranging larger insurance risks and why some businesses may choose not to use insurance as a method of dealing with some of their risks.


006 007


1.1 –Meaning of risk

During this session, we will examine the meaning of risk.

The Oxford English Dictionary lists 26 synonyms for the word ‘risk’. How many can you list out?

Write your synonyms of risk here.

Several academics have attempted to define risk, for example, ‘risk is uncertainty of a loss occurring’. Risk represents the possibility of an outcome being different from the expected.

We define the term risk as THE POSSIBILITY OF ADVERSE RESULTS FLOWING FROM ANY OCCURRENCE.

Reviewing the list of synonyms and definitions suggests that risk involves a lack of knowledge about future events (‘uncertainty’, ‘doubt’, ‘possibility’, ‘unpredictability’) and whether there will be a loss.

This idea of the unknown and loss is borne out by the use of risk in everyday language. You may have heard or used some of the following phrases:• “The risk of losing a job”• “What is the risk of an accident?” • “The risks involved in a new business venture”.

008 009

Risks are with us every day – each time we travel in a car there is a risk of an accident but our individual attitude to risk varies. Some people are considered risk-seeking, they enjoy risks perhaps it gives them a sense of excitement while others may be risk neutral. Finally, those who actively avoid risk are risk-averse.Which of the three groups are more likely to buy insurance?

The term risk is used in insurance business to also mean either a peril to be insured (fire is a risk to which a building is exposed) or a person or property protected by insurance (young drivers are often not considered good risks for Motor insurance)

1.2 –Categories of risk

We have examined risks and peoples’ attitude towards risk. We are now going to look at how risks can be classified i.e. the placing of similar risks into a group

Three categories of risks are: • Financial or non-financial• Pure or speculative• Fundamental or particular

Financial or non-financial

If the outcome can be measured in financial terms then the risk is classified as financial. It follows, therefore, that a non-financial risk is one where the outcome cannot be measured in financial terms.

Examples of financial risk include a business venture, which may show a profit, a loss or may break-even on its original investment. If a fire damages a building, the cost of rebuilding is the financial loss.


008 009

Measurement of the outcome of non-financial risks is usually not in monetary terms but by characteristics that are more personal disappointment, unhappiness, joy, pleasure etc.

Visiting a restaurant for the first time may involve an element of risk as to whether the outcome will be disappointment or pleasure. Buying a car, choosing a holiday, selecting a job all involves a degree of risk (unknown outcomes) but although the outcome may have some financial implications, a precise measurement in strictly financial terms is not possible.

If a person had only one photograph taken as a child with his father who is no more, then that photograph would, to him, have great value. However, that value is an emotional or sentimental value, a value that we cannot measure financially.

Which ty pe of risk, financial or non-financial, is usually considered as insurable and why?

Pure or speculative

A pure risk is one that has only two possible outcomes. 1- a loss 2- or break-even (No loss). A speculative risk has three possible outcomes, 1- a loss 2- or break-even (No loss) 3- or gain/profit.

The distinction is important for insurance and one that you must fully understand.Each time we travel in a car there is a risk of an accident. If there is no accident the position is unaltered, a break-even situation. If there is an accident a loss is suffered as a result of damage to the vehicle, injuries etc. There is no possibility of gain (apart from arriving safely at a destination) but there is a possibility of a loss.


010 011

Other examples of pure risk include fire, theft, explosion, and storm damage. Can you think of other examples of pure risk?

A speculative risk on the other hand involves the prospect of gain or profit. New business ventures, purchase of shares, investments - all have the prospect of loss and break-even but we usually make these decisions for the prospect of gain. It follows, therefore, that a speculative risk has three possible outcomes, loss, break-even or gain.

Which type of risk, pure or speculative is considered insurable and why?

Fundamental or ParticularThe categories of financial or non-financial and pure or speculative are concerned with the outcome of events. This classification relates more to the cause and effect of risks.

In its simplest description, fundamental risks relate to those risks that affect large groups of people. Particular risks conversely affect individuals or small limited groups of people.

Examples of fundamental risks include widespread natural disasters, (earthquake, hurricanes, flooding, famine and the like), a national economic disaster or social upheavals.


Japan Earthquake 2011

010 011

Examples of particular risk include fire in the home, motor accidents, personal injuries.

It is the effect of the risk that distinguishes between fundamental and particular. A severe economic recession, causing mass unemployment in a region is a fundamental risk. It has affected a nation’s economy and all, or many of its citizens. As individuals however many of us face the possibility of unemployment for whatever reason. The individual’s prospect of such unemployment is considered as particular.

Since fundamental risks are caused by conditions more or less beyond the control of individuals who suffer the losses and since they are not due to the fault of any one in particular, it is held that society rather than the individual has responsibility to deal with them – social insurance should be for fundamental risks – private insurance for particular risks though some fundamental risks like earthquakes are covered by private insurance.

Risks can be summarized in the following diagram:

Risk

FinancialRisk

According toEffect

PersonalRisk

PropertyRisk

LiabilityRisk

SpeculativeRisk

Particular Risk

PureRisk

General Risk

According to Source

According to Need

Non Financial Risk


012 013

1.3 - Insurable risks

So far, we have developed an understanding of the meaning of risk, that it broadly involves a lack of knowledge about future events and whether there will be a loss. From discussions and examining categories of risk, you will be aware that not all risks are insurable.

For a risk to be insurable, a number of factors need to be present.Financial Any loss suffered must be measured financially.Pure Risks Generally only pure risks are insurable i.e. a loss or break-even situation.Fortuitous Fortuitous essentially means accidental and in this context means that any event must be outside the control of the insured. It must be accidental as far as he is concerned. Insurable Interest We have already established that any loss must be capable of being measured financially. Insurable interest means that the party receiving the benefit of the policy must be the party who suffered that financial loss.

See Module 2: Legal principles of insurance; Section 2.2 for a more detailed discussion of Insurable interest.

A theft is not accidental; it is a deliberate act by the thief but is accidental or fortuitous to the victim.

A disgruntled ex-employee, recently dismissed by his employer, returns to his employer’s premises and deliberately starts a fire. Can this be considered accidental?

Your friend recently bought a new car and is well known as a terrible driver. You feel sure he will have an accident. Would you insure his car if you are an insurance company?Give reasons for your answer.


012 013

It will be recalled that fundamental risks relate to those which affect large segments of the population and particular risks relate to those which affect individuals or small groups of the population.

It cannot be stated with certainty that either is insurable – some fundamental and particular risks are; but some are not. Fundamental risks that satisfy the above criteria are usually insurable. Earthquake, storms, hurricanes and other natural disasters are, in most cases considered by the insurance industry to be insurable. 1.4 - Uninsurable risks

It has been established that to be insurable a risk should, be a pure risk, be capable of financial measurement, be fortuitous (to the insured) and there must be insurable interest. It follows therefore that risks that are the opposite i.e. primarily speculative, not capable of financial measurement, are not fortuitous and where there is no insurable interest are uninsurable.

We will now consider other factors that may make a risk uninsurable but before discussing and understanding these issues, it is important to bear in mind that society and the business world are not static environments. Attitude and circumstances change over time and what is uninsurable today may well be insurable tomorrow.

An example of this is the notion that to be insurable there must be a large number of similar risks as the absence of large numbers mean it is impossible to forecast losses and therefore calculate premiums. This notion held good for many years but it lost support when there was a demand to insure the Olympic Games for the first time and also the early space satellites. Clearly there were not a large number of these but insurance was possible, perhaps due to the entrepreneurial nature of the industry but it demonstrates how attitudes change.

Public policy is essentially anything that involves the interests of the public or society as a whole. Situations that may be legally valid but may be ethically or morally wrong are against public policy, as they are not in the public interest.


014 015

It is possible to arrange insurance against the paying of certain fines (fortuitous, financial, pure, insurable interest). However, a feature of a fine is punishment for breaking the law and such an arrangement would be against public policy and not therefore allowed. It could encourage people to break the law and the deterrent effect (a warning to others not to do the same) would be lost.

Encouraging people to break the law of another, friendly country could also be against public policy

Try to think of a situation in KSA that you consider may be against public policy.

Certain kinds of fundamental risks are also uninsurable usually because their financial consequences are so huge that the insurance industry could not possibly pay for the damage. War on land is an example. Nuclear disasters are another example. Several countries felt the consequences of Chernobyl and many are still suffering from the effects, particularly to agriculture today.

Another possibility is that the risk of the loss occurring is so high e.g. natural disasters in certain areas, that premiums become unsustainable.

We cannot be too dogmatic concerning fundamental and particular risks. In general, fundamental risks arising from social, economic or political causes would not normally be insurable. However, a fundamental risk that is uninsurable may be insurable as a particular risk.

An example of this is an economic recession causing widespread unemployment that is beyond the scope of the insurance industry and therefore uninsurable as a fundamental risk. However, an individual may be able, under certain circumstances to purchase insurance in the event of him, as an individual, becoming unemployed. This would be a particular risk.


014 015


Can you think of a situation arising from a social, economic or political cause that may be uninsurable?

1.5 - Insurance as a risk transfer mechanism

We have examined risk and can now turn our attention to the role that insurance plays in risk. It must be emphasised that insurance does not prevent, remove or cancel risks. Cars will still collide and buildings catch fire, with or without insurance. The role of insurance is to transfer the risk from one party, the insured to another, the insurer.

In 1601CE, (yes, 1601, over 400 years ago!) the UK passed an Act of Parliament laying down rules for the conduct of Marine Insurance. It included the phrase:

“The loss of any ship….followeth not the undoing of any man….but the loss alighteth easily upon many men….than heavily upon few.”

The language is old fashioned and therefore difficult to read but the sentiments expressed are the basic rationale behind insurance. A single loss, which may cause financial ruin to an individual, is not a problem when shared by several hundred i.e. the losses of the few, shared by the many.

When people purchase insurance, they are buying a promise that if certain events happen (accident, fire etc) which causes them financial loss, they will receive compensation. If the event does not happen then no financial compensation is required. That promise gives peace of mind that arises from financial security. In exchange, for a small known amount (the premium) the insured avoids the possibility of incurring a much larger unknown amount that could cause financial ruin.

016 017

There were a community of 1000 families each have a home. They decided if any home was burned they will contribute in equal shares to pay the price. Who are the few?

Who are the many?

1.6 - Pooling of risk

Insurers pay the losses of the few and share it among the many by operating a pool system. Insurers receive contributions, in the form of premiums, from all those who wish to join. They place the money into a pool and from this pool they make payments to compensate those who have suffered a loss. In addition to the losses, the pool must be big enough to pay all the costs and expenses of operating the pool.

In order for the pool to operate successfully everybody who joins must pay a fair and reasonable contribution according to the risk they transfer into the pool. This will depend partly on the size of the risk (value of a building for example) and the degree of risk i.e. the possibility of a loss occurring. A car driver with a poor accident record would need to pay more than one with a good accident record. A house owner having a house of superior construction will pay less than the one having slightly inferior construction.

Assessing the level of risk is the responsibility of the underwriter and is a concept discussed in more depth later in the course.

Consider once again our community. They decide that instead of collecting contributions from each owner after the damage; it would be better to collect from everybody on a regular weekly basis. That way they will be more certain that there is money available immediately if there is damage.Their problem was how much to collect from each owner. What is your advice? (Think about the size and degree of risk.)


016 017

To assist insurers in determining the correct degree of risk and therefore level of premium insurers make use of the law of large numbers. This simply states that the greater the number the more accurately results can be predicted.

If a coin is tossed in the air the probability of its landing heads or tails is equal, 50/50. Despite knowing this it would be difficult to accurately predict, the percentage of heads or tails if the coin is tossed 10 times. It is quite possible that the coin would have landed 7 times head and only 3 times tail. But toss it 100,000 times and we can predict with greater certainty that the outcome will be very close to 50% heads and 50% tails say 55/45 or 56/44 etc. Toss it 1,000,000 times and the situation could be 51/49 or 52/48 etc. That is bigger the sample, the greater the accuracy.

Applying this principle to insurance enables insurers to predict more accurately the future probability of losses and the degree of risk presented by contributors to the pool. It also helps to explain why insurers are willing to exchange statistical information as the greater knowledge is of assistance to everyone.

Our community plan has proved very successful. They are however concerned because in a certain year five homes will be damaged. One of the owners suggested that they should ask other close communities to join their scheme.What would be the advantages of extending the plan?

Can you think of any disadvantages?

Another aspect when assessing the level of risk is to consider frequency (how often events happen) and severity (how serious when they do happen). Risks considered by insurers are either high frequency with low severity or low frequency with high severity.


High frequency /low severity refers to incidents that occur often but individually are not financially severe. Most car accidents, thefts, or house fires would fall into this category.

Low frequency /high severity refers to incidents that do not occur very often but when they do, they may have serious financial consequences. Natural disasters such as earthquakes, hurricanes or tropical storms, a petrochemical fire etc fall into this category.

How do you think an insurance company would deal with a risk that is high frequency and high severity?

How would you deal with a risk that has low frequency and low severity?

How would you categorise aircraft accidents in terms of frequency and severity?

How would you categorise our community?


018 019

1.7 - Perils and hazards

We have seen how an insurance pool operates and how insurers use the law of large numbers and the frequency/severity profile to help determine the degree of risk.

Perils and hazards take this process a step further and permit a scrutiny of individual risks. A peril is cause of loss whereas a hazard is a condition – that may create or increase the chance of a loss arising from a given peril or under a given condition.

An example should make the distinction clear. Fire is a peril; it is something that can cause loss or damage. Construction of a building is a hazard that can influence the extent of damage if there is a loss. If we have two buildings, one constructed of brick and the other of wood. Clearly, the wooden building is the bigger risk for fire insurance. However, neither brick nor wood will, themselves cause damage but if a fire (the peril) starts then the wooden building will, all things being equal, suffer greater damage.

The construction is a hazard; it will influence the outcome but will not cause a loss, while fire is a peril, which will cause a loss.

Think about perils (things that will cause a loss) under each of the following Policy and list under each the hazards (things that will influence the extent of loss or damage) associated with that peril.

Fire Insurance on a factory building

Theft Insurance on a retail shop

Insurers divide perils into three kinds; insured, excluded (or excepted) and unnamed.


018 019


020 021

Insured perils are those specifically mentioned in the policy and states when the insurance will operate e.g. ‘loss or damage caused by fire’. Fire is an insured peril.

Excluded perils are also specifically mentioned in the policy but state when the insurance will not operate e.g., ‘loss or damage caused by fire excluding fire caused by explosion’. So if an explosion causes a fire, the policy will not cover the loss as it is an excluded peril.

Unnamed are perils not mentioned in the policy and usually they are not covered.

Insurers also divide hazards into three kinds – physical, moral and morale hazards.

Physical hazards are relatively easy to understand. They arise from the physical aspects of a risk, such as construction of a building mentioned earlier. Probably several of the hazards listed in your answer to the previous question you can classify as physical hazards.

Moral hazards arise from the immoral, unethical or illegal conduct of people, usually the person insured but in the event of a business enterprise, it could be the employees or management.

Moral hazard is always more difficult to detect because it is not physical or tangible and cannot be touched or seen. Examples of moral hazard include dishonesty by the insured, or people who do not consider deliberately inflating an insurance claim as dishonest.

In liability situations, third party claimants often exaggerate their injuries and property damage and sympathetic physicians, lawyers, body shops and contractors may support these exaggerations and increase the cost of the claims.

Morale hazard is an increase in the hazards presented by a risk arising from the insured’s indifference to loss because of the existence of insurance. In other words, Morale hazard arises from the insured’s attitude and this differs from Moral hazard as there is no conscious or malicious intent to cause a loss.


020 021

Poor morale hazard may eventually lead to physical loss or damage. A company’s management and employees who are untidy, or who do not clean the factory floor or do not follow correct safety procedures (obey no smoking signs for example) or leave machinery unguarded are all signs of poor morale hazard that could eventually lead to an accident. Their attitude and behaviour have increased the risk of a peril starting. Morale hazard acts to increase both the frequency and severity of losses when such losses are covered by insurance.

1.8 - Benefits of insurance

Module 1.5 determined that the primary function of insurance is to transfer risk, from the insured to the insurer. To facilitate the risk transfer two other functions, the common pool and fair and equitable premiums have to be in place.

Insurers gather together parties who want to share similar risks and set up a common pool to fund these risks. Insurers do not operate a single pool as the factory owner would not want contribute to losses caused by motor vehicle owners and vice versa. There is therefore not one pool but a series of pools, one for motor, one for houses etc. Although in reality there may be some transfer of money between pools for our purposes we can consider each separately.

Individual risks introduced into the pool are not identical, each has a different degree of risk according to their individual hazards and the size of each risk may be different. It is important that every contributor should make a fair and equitable contribution, according to the degree and size of their risk.

The scheme started by our Committee has proved very successful. In fact, it is so successful that factories in the area asked to join. If you admit them what factors do you need to consider when deciding on their contribution?Write your answer here.

022 023

Insurance is therefore a method of transferring risk supported by the common pool and equitable premiums. From this primary function, a number of other benefits arise to policyholders.

Peace of mind:The premium paid is a known expense but in exchange for this, policyholders receive a promise that if certain events occur they will receive financial compensation. They are exchanging a relatively small known expense in exchange for the possible avoidance of a larger unknown expense.

This provides policyholders with the principal benefit of insurance often described as, peace of mind because they are comforted by the knowledge that if a disaster should happen e.g. a fire destroying their home or business, financial compensation will be available.

Risk ImprovementInsurance companies often combine their resources and invest considerable sums of money in trying to reduce both the frequency and severity of losses. They invest in and examine new methods of loss detection, testing and developing fire fighting equipment, new methods of repairs, the use of inflammable materials in consumer goods, methods of car repairs, crash testing and so on. This may be done in conjunction with other interested parties (e.g. manufacturers, governments, fire fighters) and sometimes independently.

They share this knowledge when advising their policyholders on how to avoid or minimise their risks. This results in lower claims costs and lower premiums. It also has the added advantage that less claims means fewer accidents and therefore less personal suffering and any loss of output is reduced.


022 023

If insurers had not taken such an active interest in risk improvement what do you think would have been the outcome for: a) them, b) their policyholders and c) society overall?

As well as direct benefits to policyholders, insurance also benefits the business community as a whole.

Avoids capital retentionIf there were no insurance available then businesses would need to take into consideration the impact of losses and the cost of rectifying them. Instead of exchanging a small known amount (the premium) they would need to set aside “just in case”, capital that could be more advantageously used to expand and develop the business.

Encouraging new enterprisesStarting a new business requires capital investment often raised from investors or banks. The assets and future profits of a business are usually the security for investors who would be reluctant to invest if insurance was not available. A fire could easily make a business unprofitable and a new business is even more vulnerable.

InvestmentsAs custodians of the pool insurers have large amounts of money in their care. There is a time difference receiving premiums and paying claims, which in the case of life assurance can be several years. The funds are not left idle but are available for investment.


024 025

Insurers invest these funds in a wide range of investments, from direct equity investment in companies (stocks and shares), loans made to industry and governments, property and fixed interest securities. The small premiums paid by thousands of individuals and businesses are not idle but circulate in the economy helping to stimulate national growth.

Why do you think investors may be reluctant to invest into a new manufacturing company if the property was not properly insured?

We have looked at the benefits insurance brings to policyholders and the business community and it also brings benefits to the national economy.

Import/ExportInsurance is a commodity that, like other commodities is traded between countries and therefore a country that sells insurance is exporting and a country that buys insurance is importing. As an intangible product, i.e. it has no physical presence; it is classified as invisible earnings. Other invisible earners include tourism and banking.

A major business investing heavily in plant and equipment will want to protect that investment. If the state has either no insurance industry or one that is inadequate, that business will arrange its insurances overseas. Hence, that country will be an importer of insurance services. The overseas country that is providing or selling the insurance cover will receive the premiums and therefore be an export of the service.


024 025

Foreign ExchangeInternational deals will be done in the currency of exporting country. Many countries have a currency problem and foreign exchange is a valuable commodity the sale and purchase of which may be controlled. An established and financially sound insurance industry that can retain its own risks will assist those countries by reducing the level of foreign currency needed.

A small, undeveloped country has a nationalised insurance industry and all insurance must be placed with the state owned company, the only available insurer. They reinsure 99% with international reinsurers. What effect do you think this arrangement has on the nation’s economy?

1.9 - Reinsurance

Having accepted the risk from their policyholders, an insurance company has an interest in spreading the risks that they have accepted and transferring some of it to others. It may seem strange that insurers accept risks then transfer them on to another insurance company but there are sound commercial and financial reasons for this practice.

A broker offers an insurer a risk from a client who already has several large policies, but it considers the risk too large or too hazardous to accept. It wants therefore to decline to accept the insurance. What are the disadvantages to the insurers in refusing to accept the insurance?


026 027

Instead of refusing the business, an insurer could decide to accept the risk and arrange to transfer some of the risk to another insurance company – a process known as reinsurance.It is important to remember that there is no relationship between the insured and the reinsurer. There is a contract of insurance between the insured and the insurer and a similar arrangement between the insurer and the reinsurer but there is no legal or contractual relationship between the insured and the reinsurer. In fact, in most cases, the insured is not aware that there is any reinsurance.

As there is no relationship between the insured and the reinsurer, what do you think would be the financial consequences for the Factory and the Insurance Company A if the Reinsurance Company C went into liquidation and was unable to pay any claims?

In addition to commercial considerations, there are also financial reasons for arranging reinsurance. Insurers are custodians of the common pool, which means that they are guardians of the funds that belong to their policyholders. They therefore have a duty to safeguard that pool of money and reinsurance is a way of protecting the interests of their policyholders and their pool of money.


Re-Ins B

Re-Ins C

Re-Ins D

Factory Ins A

026 027

Peace of MindIn the same way that a policyholder secures peace of mind by buying insurance, insurers have the same objective. They would not want one single disastrous event or bad risk to jeopardize the common pool, which would cause financial problems to other policyholders. Reinsurance achieves this objective by providing protection, particularly against catastrophic losses.

Underwriting StabilityA major expense for insurers is the cost of claims and an individual insurer would not like to have these costs fluctuating wildly from year to year. Reinsurance provides a method of ensuring that the underwriting results (premium minus claims equals underwriting result) and the loss ratio (claims ÷ premium) are stable each year.


Underwriting Result

Underwriting Result

028 029

Consider the above figures of two insurance companies. In which one would you prefer to insure and why do you think it is important that an insurance company does not allow its loss ratio and underwriting results to fluctuate wildly from year to year?

Reinsurance contracts are either proportional or non-proportional.

Proportional means the insurer and reinsurer share the risk, the premiums and claims, usually on a percentage basis. For example, the reinsurer may agree to accept, say 25% of the risk receiving 25% of the original premium and paying 25% of all claims.

Non-proportional reinsurance means that the insurers and reinsurers do not share premiums and claims equally. Typically, it involves a deductible, usually quite substantial that the insurer must pay before the reinsurer will contribute to any claim. For example, a reinsurance policy issued with SR10M excess only requires reinsurers to contribute when a loss exceeds this amount.

Reinsurers agree to accept 15% of a risk. If the premium received by the insurance company is SR150M how much reinsurance premium will reinsurers receive?

Reinsurers agree to reinsurer all losses that exceed SR15M. The insurance company settles a claim for SR25M. How much will they recover from reinsurers?

There are two main forms of reinsurance, facultative and treaty. Facultative was the original method of arranging reinsurance but today the vast majority of reinsurance is treaty.


028 029

FacultativeFacultative is a French word that means optional or by request and insurers have to request facultative reinsurance when they need it. This means that the insurer has to contact the reinsurer, give details of the original risk, together with all material facts concerning the risk. If the reinsurer refuses or the terms are too high, the insurer will need to find another reinsurer.

Although a specialist reinsurance broker can help, the process is still time consuming, administratively expensive and there is always uncertainty if the reinsurance will be at acceptable terms.

It may be required however when:• The treaty is full• The risk is outside the treaty terms• The risk is unusual

Why do you think the time delay and uncertainty cause problems for the insurer?

TreatyA treaty is an agreement between insurers and reinsurers. Under the treaty, reinsurers are obliged to accept all the risks that are within the defined limits of the treaty. Treaties typically are signed for one year and then if both parties agree can be renewed. Reinsurers therefore agree in advance to accept reinsurance business given to them by the insurer. The major benefit to insurers is that they know they have reinsurance protection and they know the cost of that protection immediately they accept a risk from a client.


030 031

The insurance company has a treaty with a reinsurer in which the reinsurers agree to accept 25% of all fire policies issued by the insurance company. The reinsurer notices that the insurance company has agreed insurance on a particular term that they did not wish to reinsure. Can the reinsurer refuse to accept the reinsurance? Give reasons for your answer.

1.10 - Co-insurance and self-insurance

Co-InsuranceFor the risk that is either too large or too hazardous for an insurer to accept, there is a second option apart from reinsurance. Instead of accepting 100% of the risk and then arranging reinsurance the insurer can accept a lower percentage of the risk, an amount which is within its capacity and the insured, or his advisers will need to find another local insurer (or insurers) to accept the balance.

The insurers who share the risk, usually along percentage lines are co-insurers and the practice known as co-insurance. It is a common practice in many insurance markets and usually involves the insurance of larger risks, often arranged through an intermediary, typically an insurance broker.

The broker would probably prefer to place all the business with one insurer but if this is difficult, he will arrange co-insurance. It will be his responsibility to place the insurance 100% and not leave the insured with only partial cover. The broker will also handle a great deal of the administrative work.

The process usually operates by the broker approaching an insurer whom he thinks will want to do the business. This first company decides the premium and other terms, may arrange an inspection and survey of the insured’s premises, will issue the policy and is the lead insurer. The broker will then approach other insurers who will have to decide whether they are prepared to follow the terms and conditions agreed by the lead company. The broker continues until the insurance is covered 100%.


030 031

It is important to note that each insurer is in contract with the insured but only up to his specified percentage.

See Module 2: Legal principles of insurance; Section 2.5 for a more detailed discussion of Co-insurance and Contribution.

If, in the case outlined above Insurer ‘C’ went into liquidation what effect do you think this will have on the insured and on the remaining three co-insurers?

Self-InsuranceInsurance provides peace of mind because by transferring risk the losses of the few are shared by the many and therefore a loss that may be disastrous for an individual is acceptable when shared by several hundred.

There may however be circumstances when an individual or business may choose to retain the risk. This is self-insurance and should not be confused with no insurance. No insurance occurs when a person or business simply ignores the risk, does nothing and does not arrange to pay for any losses that may occur. Self-insurance is a deliberate and conscious decision to retain risk.

A business faced with a risk that it considers small and well within its financial ability may choose to retain such a risk. The risk may be low severity/low frequency but even with high frequency, a wide geographical spread may bring it within their capacity to manage the risks themselves.


Co-Insurer A 50%

Co-Insurer C 15%

Co-Insurer B 25%Insured

Co-Insurer D 10%

032 033


The business may decide to self-insure possibly by putting the equivalent of the premium aside, which can then be used to pay for losses. It should save on the insurer’s administration costs and premiums and the funds could also generate a return if invested sensibly.

A clothing store has 250 shops, nationwide situated in all principal towns and shopping centres. Each shop has a plate glass front which if broken would cost at least SAR5,000 to replace. Why may this company choose not to insure?

What disadvantages, if any are there in choosing to retain the risk?

See Module 4: The insurance market; Section 4.1 for a more detailed discussion of Captive insurance company which is a type of self insurance.

1.11 -How an insurance company operates

The business models (see diagrams below) for insurance companies, whether general insurers or protection and savings insurers, shows that insurers seek to make a profit in two ways: (1) through underwriting, the process by which insurers select and price the risks they insure, and (2) from investment income arising from the investment of the premiums they collect from their policyholders.

032 033


Within these models are several key operational functions. These include:

1. Rate making:Is the process of calculating the premium for a risk so that the money obtained by the insurance company for the risk is adequate, reasonable and not unfairly discriminatory.

See Module 3: Risk Underwriting; Section 3.2 for a more detailed information on the Rate making process.

2. UnderwritingSelecting a risk and deciding the price for the risk

See Module 3: Risk Underwriting for a more detailed discussion of the Underwriting process.

The General InsuranceBusiness Model - Cash Flow

In

OperatingExpenses

ClaimsExpensesTaxes

Return on InvestedPremiums

Premiums Paid Claims Paidand Reservesfor Reported

Losses

OUT

034 035


3. Production(Sales and Marketing) – generating new business

See Module 4: The insurance market; Section 4.3 for a more detailed discussion of the different Marketing and Distribution channels.

4. Claim settlement

See Module 5: The need for documentation; section 5.4 for a more detailed discussion of Claim forms.

5. Reinsurance

6. Maintaining a fund

See Module 6: Regulation of the Insurance Industry in the Kingdom; section 6.3 for a more detailed discussion on Maintaining funds.

7. Investments

See Module 6: Regulation of the Insurance Industry in the Kingdom; section 6.3 for a more detailed discussion of Investments.

8. Distributing surpluses

See Module 6: Regulation of the Insurance Industry in the Kingdom; section 6.3 for a more detailed discussion on Distributing surplus.

Progress CheckDirections: Choose the best answer to each question.

1. Which of the following examples is speculative risk?a. A situation that has three possible outcomes, either loss, break-

even or gain.b. A widespread natural disasterc. A situation which has only two possible outcomes, loss or break-

evend. A loss which affects only a few people

2. Insurance deals with risk through a system ofa. Risk preventionb. Risk avoidancec. Risk transferd. Risk removal

3. The law of large numbers assists insurers because:a. It helps to make reliable claim predictionsb. It helps to determine overheadsc. It helps to make reliable income predictionsd. It helps to forecast the level of new business

4. To be insurable a risk must, as far as the insured is concerned bea. Speculative and fortuitousb. Pure and fortuitousc. Inevitable and pured. Speculative and inevitable

5. Insurable interest can be defined as:a. More than one insurance policy covering same riskb. Putting back the insured in same financial position at inception of

policyc. Putting back the insured in same financial position just before the

lossd. The person benefits from insurance is the same person who suffers

the financial loss

034 035


036 037


6. Public policy can be described as:a. The financial relation with the subject matter insuredb. The conditions in the policyc. The laws of the countryd. The exclusions in the policy

7. What is meant by “a peril”?a. Increase the damageb. Decrease the damagec. Cause the damaged. Has no effect on the damage

8. What is meant by “a hazard”?a. Affect the extent of damageb. Cause the damagec. Decrease the damaged. Does not affect the damage

9. The difference between, moral and morale hazards is thata. Moral is intentional while morale can be seenb. Moral is intentional while morale is unintentionalc. Moral is unintentional while morale is intentionald. All of the above

10. Why is it necessary for a risk to be capable of financial measurement before it can be considered as insurable?

a. To be indemnifiedb. To have insurable interestc. To be pure riskd. All of the above

11. What do you think would be the effects on a nation’s economy if a country had no insurance industry but despite this allowed overseas companies to invest?

a. It will be exporting insuranceb. It will be importingc. It will support the local currencyd. It will keep all the investment inside the country

036 037


12. A factory is seeking insurance for $100M on its buildings. Insurance Company “A” accepts the risk and reinsures with, “B”, “C”, “D” and “E” who each take 20% of the risk. A claim is submitted and agreed at $10M. How much will company “D” pay and whom will they pay?

a. 2M to the factoryb. 10M to the factoryc. 8M to company Ad. 2M to company A

13. The same factory approaches insurance company “L” who will only take 20% of the insurance but insurance companies “M”, “N”, “O” and “P” all agree to accept 20% each. A claim is submitted and agreed at $10M. How much will company “N” pay and whom will they pay?

a. 2M to the factoryb. 10M to the factoryc. 8M to company Ad. 2M to company A

14. Mr. Ali buys a car. He does not arrange insurance because he has never heard of insurance. This is example of:

a. Self insuranceb. No insurancec. Retaining riskd. Self risk management

15. The difference between facultative and treaty reinsurance is:a. Facultative is optional while in treaty the reinsurer accept all the risks

that are within the defined limits b. Facultative is less costly than treatyc. Facultative is usually for a yeard. All of the above is correct

16. What is The difference between proportional and non-proportional reinsurance?

a. Proportional is agreeing on a certain amount while non proportional is agreeing on a certain percentage

b. Proportional is usually treaty while non proportional is facultativec. Proportional is agreeing on a certain percentage while non

proportional is agreeing on a certain amountd. Non Proportional is usually treaty while proportional is facultative

Module 2:Legal Principles of Insurance

After studying this module, you should be able to understand the following legal principles:

Utmost good faith- define utmost good faith- define a material fact and describe its importance- describe the consequences of non-disclosure or misrepresentationInsurable interest- define insurable interest- understand when insurable interest commonly arises in different classes of insuranceIndemnity- define indemnity- identify the policies that modify indemnitySubrogation- define subrogation- understand when subrogation is appliedContribution- define contribution- identify different methods of contributionProximate cause- define proximate cause- distinguish between insured, expected and uninsured perils

040 041


IntroductionInsurance developed several hundreds of years ago in response to a basic human need, to avoid hardship and suffering. Since that time it has grown into a major worldwide industry and as it has developed, so have a number of principles that govern its workings.

In this module, we study the insurance principles. This is an important module because the principles are the foundations for the business of insurance as it is practised. A proper understanding of these principles will enable you to understand why many insurance practices are done in the manner they are done.

Utmost good faith is a legal principle governing the formation of the contract and we take another closer look at insurable interest. Indemnity and its supporting principles, subrogation and contribution control how much the insured can receive as compensation and finally proximate cause is used to assist in determining the cause of loss.

The principles relate to all classes of insurance, (Marine, Life and General) although there are variations in the way they are applied to each.

040 041


2.1 - Utmost good faith

When buying a product, a car, TV etc, the buyer can examine the goods and the seller does not have to say anything although any question from the buyer must be truthfully answered. The legal principle governing such contracts is caveat emptor - let the buyer beware - it is up to the two parties (but mainly the buyer) to ensure that they are satisfied with the terms. Neither party is under any obligation to volunteer any facts or information to the other. This is not the case with insurance.

In insurance, the insurer must rely on the truthfulness and integrity of the proposer. In return, the insured must rely on the insurer’s promise to pay future claims. Further only one party (the proposer) knows all the facts about himself and the ‘thing’ to be insured. Insurance is therefore subject to a much stricter duty than let the buyer beware it is the duty of Utmost Good Faith.

Utmost Good Faith is a duty of disclosure because each party must voluntarily disclose all information; they cannot remain silent. Utmost Good Faith applies to both insurer and insured although it is a more onerous duty on the proposer.

An insurance company is aware that the insured is entitled to a discount on his premium, as he has made no claims for the previous year. The insured does not ask for his discount and the insurance company remains silent. Is this a breach of the duty of utmost good faith?

Utmost Good Faith is a duty of disclosure and all parties to the contract are obliged to disclose all material facts.

A material fact is defined as a fact that would influence the judgement of a prudent insurer in deciding whether to accept a risk for insurance and if so the terms and conditions that should apply, e.g. premium, conditions, deductibles etc.

042 043


The duty of disclosure begins at the start of negotiations and continues until the contract is in force. After that, both parties are subject to the terms and conditions of the contract. However, even if there were changes after inception, the insured should disclose them. Most policies contain a condition that the insured must disclose any alteration that increases the possibility of loss. Even without this condition, the insured should disclose any such alteration because the essential terms of contract have altered.

Insurance contracts are issued for a period of time, 12 months being the most common. At expiry insurers usually offer to renew the policy. The terms and conditions may change but even if renewal is on existing terms, the renewal is a new contract. The duty of utmost good faith, therefore, revives at renewal and both parties must voluntarily disclose any changes.

A landlord takes out a fire policy on his building. Two months after the contract the tenant who used the building as a warehouse for storing groceries moves out and a new tenant, who is using the building as a garage and motor repair shop moves in. Do you think the landlord should notify his insurers of the change in risk? Give reasons for your answer.

A material fact is one that influences the decision of the insurer to accept or decline risks or continue with an existing risk. Determining exactly what a material fact is can be difficult especially for proposers who are new to insurance. A proposal form normally asks for those facts generally considered material by insurers. However, if there are other facts not covered by the proposal then the proposer should voluntarily disclose them; staying silent is not an option. Many insurance companies remind the proposer to disclose any other information that may be relevant to the insurance. The general rule is, if in doubt regarding the relevance, disclose the information.

042 043


Facts that require disclosure include:• A full description of the subject matter of the insurance. The car,

property, liability etc.• Any other policies covering the same risk• Previous insurances. Especially relevant if an insurance company has

declined insurance or imposed special or restrictive terms.• Details of previous losses and insurance claims.• Any fact that increases the risk from normal. For example, a car

engine modified to make it go faster.

Some of the information disclosed will relate to the subject matter of the insurance and these are primarily physical hazards. Others relate to the person taking out the insurance and are primarily be moral hazards.

There are some facts that do not need disclosing. These include:• Facts of law. The assumption is that everyone knows the law and

ignorance is not a defence.• Facts of public or common knowledge. This could include well-

known flood or crime areas, earthquake zones, war areas, trade and industrial processes.

• Facts that lessen the risk. Additional fire or security precautions for example.

• When further information has been waived. If there is a blank or inadequate answer on a proposal that insurers do not follow up the assumption is they have accepted the position and cannot later rely on facts they do not like.

A question on the proposal form asks: ‘Have you ever suffered any previous losses?’ The proposer answers with a dash ( - ). Later, when investigating a claim, insurers discover that the proposer had a history of losses. Do you think they could refuse to pay the claim? Give reasons for your answer.

044 045


A breach of utmost good faith is typically either non-disclosure i.e. failing to disclose a material fact or misrepresentation i.e. incorrect or inadequate disclosure. A breach that is a deliberate misrepresentation of the facts may be fraudulent and referred to as concealment.

The breach leaves the injured party, typically the insurance company with the option to:• Cancel the contract from the beginning – almost as if it never existed.• Insurers usually discover breaches at the time of a claim and refusing

to pay the claim is an option.• Insurers may choose to charge additional premium or impose

additional terms on the policy.• They may choose to ignore the breach and just continue with the

insurance.

Although unlikely, in the event that the insured suffers a breach, he will be able to recover any damages that he has suffered.

Khalid bought an old building to store his stock. The previous owner told him that the building suffers from flood damage from a nearby river because every time it rained the river flooded. He does not tell insurers. Later the river floods, stock damaged and a claim submitted. Could insurers refuse to pay the claim? Give reasons for your answer.

2.2 - Insurable Interest

Insurable Interest means that the person receiving the benefit of the insurance policy must have suffered a financial loss when the insured item suffers loss or damage.

To emphasise the importance of insurable interest, in a fire policy, it is not the building that is insured but the insured’s interest in that building. This is insurable interest and is the legal right to insure. Without insurable interest, an insurance policy becomes invalid as it ceases to be an insurance contract but almost a gambling contract.

044 045


It follows that a legal relationship, between the person affecting the insurance and the ‘thing’ being insured, must exist. The most common of these is ownership. Clearly if a piece of property, car, house, camera, watch, gold pen or whatever is damaged the owner will suffer financially. Consequently, the owner has insurable interest in his property.

It is also possible to have an insurable interest in property that is not owned but is in another person’s possession. Although with that possession should be responsibility for the property. Garages, laundries, hotels, airlines, repair shops and warehouses are just a few examples of people who are in possession of property not belonging to them but because they are responsible for its safety they have insurable interest.

Note that the owner of the property also has insurable interest and it is possible for both parties to insure these items.

You are leaving for a month’s holiday touring Europe. You borrow a camera from your friend. Do you have insurable interest in the camera?

We have referred to the ‘thing’ being insured and given property as an example but the ‘thing’ can be an individual’s life or limb. We all have an insurable interest in our own life to an unlimited extent but we can also have insurable interest in the life of others.

Being a relative does not necessarily create insurable interest, as there must be a financial loss on the death of the life insured. There might be emotional loss on the death of a relative or close friend but not necessarily a financial loss.

Families do however have insurable interest in the life of the ‘breadwinner’; business partners may have interest in each other’s lives; a bank has insurable interest to the extent of the amount of any loan they make.

Insurable interest varies slightly depending on the branch of insurance - Marine, Life or General.

046 047


MarineIn marine insurance, there must be insurable interest at the time a loss occurs and not necessarily at policy inception. The nature of marine business is such that goods can be in transit for several months and its ownership could change during the journey. Therefore, the person who may have taken out the insurance may not be the person who suffers the loss.

LifeIt has been established that in life insurance insurable interest has only to be present when the policy is taken out and not necessarily when the loss occurs - the opposite of Marine Insurance. This may seem a strange position but is not really a problem. If for example a bank requires a life policy as a condition for a substantial loan, the debtor takes out the insurance on his life and names the bank as the beneficiary for the proceeds. If the loan is paid, the insured can simply change the beneficiary, or cancel the insurance.

General InsuranceFor all other policies, insurable interest must exist at policy inception, during the currency of the policy and when the loss occurs. If there is an absence of insurable interest when the insurance starts then the contract may be considered invalid and if there is no insurable interest at the time of the loss then there will be no loss to the insured.

2.3 - Indemnity

Indemnity in many ways is linked to Insurable Interest. Insurance contracts to be valid must have Insurable Interest i.e. the insured must suffer financially from the loss or damage to the ‘thing’ insured but that Insurable Interest is limited to the financial interest.

046 047


An owner has Insurable Interest in his own property but only to the extent of the value of that property. Recover more and he would be financially better off after a loss than before a loss. This would breach the principle of indemnity and render insurance a gambling proposition..

The Principle of Indemnity is to put the insured in the same financial position after a loss as he was in immediately before the loss. In theory, he should be neither better off nor worse off but the same. In practice, this is very difficult to achieve but it does not detract from the basic principle, which many consider the foundation of insurance.

Indemnity is therefore the maximum financial interest that the insured has in the insured item. However, it is not possible to place a monetary value on a human life and we all have an unlimited interest in our own life and limbs.

Therefore, life insurance and personal accident policies (excluding medical expenses) are not policies of indemnity and the principle of indemnity does not apply to them.

If the insured is to be in the same financial position after a loss as he was before the loss, it is necessary to establish the value of any items lost or destroyed at the time of loss.

Example:Ali has a car model 2008 insured with a comprehensive insurance policy. He had a car accident that damaged the head lights and the radiator

If Ali is given the new replacement price he would be able to purchase new items whereas before the loss he had old items, so he would be better off. To arrive at indemnity it is necessary to make a deduction from the new price to make allowances for the age and previous use of these items, known as wear and tear and depreciation.

Indemnity should not include any element of profit. Therefore, a shopkeeper who has his stock damaged should be indemnified with the cost price to replace that stock – it is not the selling price, which would include his profit.

In liability insurance the amount of indemnity would be limited to the damages suffered by the third party with his costs.

Having established Indemnity, the insurance contract states that the method of providing the Indemnity is at the option of insurers. The typical policy lays down four options and insurers will normally elect the option that is most convenient and least costly to them.

Monetary paymentIn the majority of cases, this is the most convenient method and insurers reimburse the insured by cheque.

RepairInsurers may arrange for a damaged item to be repaired at their expense. Collision damage to motor vehicles is a common example where insurers arrange repairs. In some cases, insurance companies own or have a financial interest in repair shops, which help them to control costs. Alternatively, they may receive discounts from repairers due to the volume of business.

ReplacementInsurers may choose to replace an item that has either been lost or damaged beyond repair. Glass insurance, jewellery, house contents are examples of replacement, again the insurance company usually gets the benefit of discounts for the volume of business they supply.

ReinstatementReinstatement tends to refer to buildings or machinery and is similar to repair. Insurers may choose to undertake to rebuild the damaged building themselves. An option rarely exercised because of the problems it can cause insurers. They would normally expect the insured to arrange the work and limit their role to verifying that the work is in order and within the policy terms. They then reimburse their insured.

048 049


A vehicle is damaged in an accident. The insured takes it to a garage who estimates the cost of repairs as SR1,000. He submits a claim to his insurers but due to their bulk purchasing power insurers can have the vehicle repaired for SR 850. The insured states that he does not want to have the vehicle repaired. He requests a cash settlement of SR1,000. Does he have the right to this? Who chooses the type of compensation?

Indemnity is a principle underpinning insurance but in order to satisfy the needs of policyholders it must be flexible. Insurers have policies that alter slightly the strict principle of indemnity but achieve the overall objective of attempting to put the insured in the same financial position after the loss as he was immediately before the loss.

Agreed ValueIn some cases it may be difficult to assess the value of an item on the day of loss, especially if that item is rare e.g. an antique work, a master’s painting. In these circumstances, insurers offer an agreed value policy. In these contracts, the value to be paid in the event of a total loss is agreed at inception of the policy. Note only the total loss value is agreed, any partial loss would be handled in the usual manner e.g. cost of repairs. It does mean however that if the value changes between inception and loss date (which could be up to a year later) the agreed value that is paid may differ from the indemnity value on the day of the loss.

Agreed value policies are rarely used in non-marine insurance but are very common in marine insurance where the value of cargo can fluctuate during a long voyage and replacing the goods may be difficult in view of the time and distances involved.

048 049


A painting insured for SR100,000 on an agreed value policy is destroyed in a fire. Its value on the day of the loss was SR75,000. How much will the insured receive? Give reasons for your answer.

First LossA situation may arise when the insured feels the probability of a total loss is so remote that full insurance is not necessary. For example, in a large warehouse containing heavy goods it is unlikely that thieves could remove all the contents in a single loss. In these circumstances a first loss policy, which permits less than full value insurance, is appropriate.

The insured selects the amount they feel is the maximum they could suffer from any one loss and this becomes the first loss sum insured and is the maximum payable in respect of any one claim. The full value of the property is noted but only for information and to aid in premium calculation. It does mean that if the insured has made a mistake and does suffer a loss in excess of the first loss sum insured he would not be able to receive a full indemnity.

AlMuttahida have a first loss policy for SR500,000 although they have property valued at SR2M in their warehouse. While closed during a holiday period thieves break in and remove property valued at SR600,000. What is the maximum the insurer can pay?Give reasons for your answer.

In addition to these two types of policy, many other policies contain conditions that can affect the amount the insured can receive as indemnity.

050 051


AverageIt was stated earlier in the course that insurance is based upon the common pool and that all contributors must contribute to the pool according to the degree and size of the risk being introduced.

In the event that somebody undervalues his property, he will not be making a fair and equitable contribution, as he will be paying less premium than his risk demands. Insurers, therefore, penalise the insured for any underinsurance by reducing his claim at the same proportion that the sum insured is to the full value.

Unless there is a claim the underinsurance may not be discovered and it will be too late to recover unpaid premiums possibly going back several years.

ExampleIf a shopkeeper insures his stock for SR 50,000 but at the time of the loss, the full value of his stock was SR100,000 then the claim will be reduced by the same proportion – 50%. If the claim was SR15,000 he will receive SR 7,500. It can be expressed as follows:

Replacing these with figures above:

If average applies then the insured will not receive a full indemnity.

Al Ikhlas Foods has a fire policy insuring their factory for SR1M. There is a fire and the cost of repairs is agreed at SR 240,000. The loss adjuster notes that the actual value of the factory at the time of the loss was SR1.5M. How much can Al Ikhlas receive under the terms of the policy?Show your calculation.

050 051


Sums InsuredThe sum insured is insurer’s maximum indemnity and they cannot pay more than this amount. In the event the insured suffers a total loss of a property that is underinsured he will not receive a full indemnity. However, some policies have sub limits or inner limits.

For example, house insurance may have a limit any one item or a limit in respect of valuables.

DeductiblesAlso known as ‘excess’ These are the first amounts payable by the insured and are deducted from any claim payment. Some deductibles are voluntary, which means that the insured has elected to have the deductible usually in return for a reduced premium. Others are compulsory because insurers have imposed them, usually to encourage the insured to be careful.

ReinstatementThis condition simply states that indemnity will be the full cost of replacement without any deductions for wear and tear i.e. he will receive the value of new goods.

The condition is quite common in policies covering commercial buildings and machinery where deductions in any event may be quite small but where huge funds are needed to continue the business.

The reinstatement condition is available in house insurance policies and referred to as ‘new for old’. The reason is to avoid hardship when if the homeowner loses a substantial part of his home indemnity only cover may not provide enough to refurnish the home. Although not common in KSA, in other parts of the world, notably the UK almost every home policy is on this basis.

Why do you think an insurance company will give a discount from the premium if the insured voluntarily agrees to pay the first SR 2,500 of any claim instead of 1500 SAR?

052 053


2.4 - Subrogation

Subrogation supports the Principle of Indemnity and does not apply to insurance policies that are not contracts of Indemnity.

Identify two policies that are not contracts of indemnity. Explain why they are not contracts of indemnity.

The principle of indemnity is to place the insured in the same financial position after a loss as he was in at the time of the loss. There are circumstances, however, when an insured has the possibility to claim from more than one party. If he did so successfully, he would receive two payments and make a profit from his loss. This breaches the principle of indemnity.

Example: “A” is waiting in his car at a red traffic light. “B” is approaching the red light but failed to apply break in time and crashes into the rear of A’s car causing serious damage. Fortunately, “A” has an insurance policy that will pay for the repairs to his car. However, he also has the option to make a claim against “B”. What he cannot do is make two claims, one against his own insurance company and the other against B’s.

In this example, if A chooses to ask his insurance company to pay his claim (which is the sensible option as “B” may not be willing to pay him) then the insurance company can act in Ahmed’s name and try to recover from “B” (or his insurers).

This is the principle of subrogation, and means that an insured cannot recover his loss a second time from another party if his insurer has settled his claim. Those rights of recovery pass to the insurer.

052 053


054 055


Subrogation exists as a right but only after the Insurers have settled the claim. Many claims can however take several months if not years to settle, very serious fire claims for example or major bodily injury. Insurers would not want to wait before attempting a recovery neither would they want their insured to start actions that could spoil their chances of success.

Insurance policies, therefore, have a policy condition that states insurers may pursue a claim against another party in the insured’s name before payment. Effectively insurers can start recovery actions immediately after they are aware of the loss.

In addition to legal rights against a negligent party, Subrogation rights can also happen under a contract e.g. tenancy or warehouse agreements. A breach of a contract term may entitle one party to compensation. If appropriate, these rights could pass to insurers.

Following a theft from Ahmed’s shop, his insurers pay him SR 5,000 in full indemnity. The thief following his arrest repays to Ahmed the SR 5, 000 he has stolen. What should Ahmed do with the SR 5, 000?

In the same example above, the insurers pay Ahmed only SR 3,000 whereas the sum insured under the policy is SR 5,000 as Ahmed is unable to substantiate his claim for full amount. The Police, however, recovers full amount from the thief and passes on the same to the insurers as they hold the subrogation rights.What should insurer do with the SR 5, 000?

When insurers agree to pay a total loss claim, e.g. when a car is so badly damaged that repairs are impossible, there may be some salvage value in the damaged property. As the insured has received a full indemnity, if he kept the salvage he would be in an improved position.

054 055


Therefore, the rights in the salvage pass to insurers as part of their subrogation rights.

Adel’s car is irreparable following an accident. Its value is SR100, 000 and he receives this from his insurers. A dealer says he can break up the old car for spare parts and offers Adel SR10, 000 for the wreck, which Adel accepts. Should Adel keep the money?

Insurers have subrogation rights only in respect of losses for which they have provided an indemnity. If there are uninsured losses such as loss of wages, car hire then the insured can still attempt to claim these from the third party.

In many of the larger insurance markets insurers enter into agreements not to recover from each other. The reasoning is the principle of ‘swings and roundabouts’ (what we gain on the swings we lose on the roundabouts and the result is stalemate). This is due to the large number of claims and consequently the large number of times insurers are trying to recover from each other. It becomes more cost effective not to recover.

In some countries, in Motor insurance, the insurers have an agreement called «knock for knock» under which each insurer pays the claim for the motor vehicle under their policies and refrain from proceeding against the insurer of the opposite vehicle. 2.5 - Contribution

If an insured takes out two insurance policies covering the same risk, he would have dual or double insurance. To allow recovery from both insurance companies would breach the principle of indemnity. Contribution is similar to subrogation; it exists to support the Principle of Indemnity and like Subrogation, applies only to contracts of indemnity.

056 057

Principles and Practices of Insurance Principles and Practices of Insurance

Dual insurance is not usually intentional but may happen through a misunderstanding. Examples include:

• The company secretary and financial manager both believing it is their responsibility to deal with the company’s insurance.

• The owner of goods and the owner of the warehouse both insure goods stored in the warehouse.

• Cover under two policies overlap e.g. holiday insurance and a house policy.

Insurers allow for dual insurance by a contribution condition in their policies, which states that in the event of more than one policy they will only pay their share. This is the contribution or other insurance condition.

The share that each insurer agrees to pay is their rateable proportion of any loss. There are two methods of calculating an insurers’ rateable proportion, based on either sums insured or independent liability.

Sums Insured MethodIn this method, the contribution to be paid by each insurer is calculated by apportioning it according to the sums insured under each policy.Each insurer pays according to the formula

Example Policy “A” has a sum insured of SR 100,000.Policy “B” has a sum insured of SR 400,000The loss is SR10,000Therefore: Policy “A” pays

Policy “B” pays

Insured Receives SR 10,000

056 057


The method is adequate for property insurance when the policies in contribution are identical in the cover they provide.

Independent Liability Method

The alternative method is suitable for policies that are not identical; they may include deductibles, loss limits or when average applies. They are also suitable for non-property policies e.g. liability insurances.

The independent liability is arrived at by calculating how much each policy would have paid had it been the only policy issued. Each policy is calculated and then the claim is apportioned according to the total of independent liabilities.

The formula is:

Example

Policy “A” has a sum insured of SR 100,000 and a deductible of SR 500.Policy “B” has a sum insured of SR 400,000 and a deductible of SR 1000The loss is SR 10,000.

Independent Liability of Policy “A” is SR 9,500 (10,000-500)Independent Liability of Policy “B” is SR 9,000 (10,000-1000)

Policy “A” pays

Policy “B” pays:

Insured receives SR 10,000

058 059


The correct method is the one that is most appropriate for the circumstances.

Similar to subrogation, larger insurance markets have agreements on contribution. The method to use, when contribution is not appropriate (if less than a certain amount only one insurer will pay), which policy should take preference. A policy that is more specific would pay first. For example, if one policy covers jewellery and another a diamond ring. If the policies are in contribution then diamond ring is more specific than jewellery. The diamond ring policy will pay and not seek contribution.

2.6 - Proximate Cause

When a loss occurs before making a decision concerning settlement, it is necessary to determine the cause of the loss. In the majority of cases, there is one cause of loss but there are occasions when there is more than one event. In these circumstances, the rules of proximate cause assist in determining the cause of loss.

After establishing the cause, it is necessary to interpret the policy wording to see if the loss is insured or not. The cause will fall under one of the following three headings:

An Insured PerilThis is a peril specifically mentioned in the policy as covered by the policy. A fire policy will specifically mention that losses caused by fire are insured.

An Excluded PerilThis is a peril specifically mentioned in the policy as not covered. A fire policy specifically mentions a fire caused by an earthquake is not covered.

Other Unnamed PerilsThese are perils not mentioned in the policy. If the cause of loss is an unnamed peril, it is not covered. The fire policy does not mention the peril of theft. It is therefore neither an insured nor an excluded peril but simply an unnamed peril.

058 059


An earthquake knocks over a burning oil-stove. The building catches fire which spreads to the adjacent building. A third building 5000 meters away catches fire due to wind blowing in that direction. The owners of the third building submit a claim. The policy covers fire (an insured peril) but not losses caused by earthquake (an excluded peril).Do you think insurers should pay the claim or does the exclusion apply?Give reasons for your answer.

If there is a series of events there must be a direct link between the cause and resulting loss. Each action should be the natural consequence of the previous with nothing new intervening to change the effect. The proximate cause is not necessarily the first or the last cause but is usually the dominant cause. The cause that has set in motion a chain of events that results in a loss.

Khalid falls from his horse and breaks his leg. Unable to move he remains alone for several hours, exposed to the cold weather, eventually catches an infection and dies. He had a policy that insured against accidental death but not death caused by illness. Do you think insurers should pay the claim?

In order to determine the answer we need to identify the proximate cause of the loss. Is it an insured peril (fall from the horse) or an excluded peril (the infection).

What do you think? Remember the proximate cause is the one that sets in motion a train of events without any new and intervening event.

060 061


Consider now the same circumstances, but this time Khalid’s riding companion is able to call for assistance and Khalid goes immediately to the hospital. Several days later, still in the hospital Khalid catches an infection and dies.

What do you think is the proximate cause? What is different from the question above? Has something new happened?

Ahmed is cleaning windows in the third floor of building. He suffers a heart attack and falls down from the third floor and dies.

Ahmed’s family claims under personal accident policy.

What do you think is the proximate cause? Is the claim payable?

Consider now the same circumstances; Ahmed is cleaning windows in the third floor of a building. He slips from the ladder and falls down. Due to shock he suffers a heart attack and dies.

What do you think is the proximate cause? Is the claim payable?

060 061



1. Utmost Good Faith can be defined as:a. The financial relationship between the insured and subject matterb. The right to claim from third partyc. The duty of disclosure of all material factsd. All of the above

2. Indicate which of the following is correct. Utmost Good Faith applies to:a. The proposer onlyb. The insurance company onlyc. Both the proposer and the insurance companyd. Non of the above

3. A Material Fact is the fact that:a. Should not be disclosedb. Affect the premiumc. Affect the conditionsd. Affects the decision of the underwriter to accept or reject the risk

4. The age of the policy holder is a material fact in:a. Fire policy on a buildingb. Theft policy on a retail shopc. Private car policyd. Contractors all risk

5. In the proposal of comprehensive motor insurance; some of material facts that may help an underwriter assess moral hazard a. The model of the carb. The usage of the carc. The age of the proposerd. The previous losses

6. Insurable Interest can be defined as:a. The financial relationship between the insured and subject matterb. The right to claim from third partyc. The duty of disclosure of all material factsd. All of the above

062 063


7. Indicate when Insurable Interest must exist in General Insurance?a. At the beginningb. During the policyc. At the time of lossd. All of the above

8. A shopkeeper has 1000 pairs of shoes in stock. He buys them for SR50 each and sells them for SR100 each. How much should he insure them?a. 1000b. 5000c. 50000d. 100000

9. Following a fire, damage amounts to SR15,000 in respect of stock insured for SR100,000. The loss adjuster advises that the value of stock on the day of loss was SR150,000. How will insurers calculate the settlement?a. (100,000/150,000) *15,000b. (150,000/100,000) *15,000c. (100,000/15,000) *150,000d. (150,000/15,000) *100,000

10. A policy has a SR1,000 deductible. A loss is agreed at SR10,000. How much will the insured receive?a. 1000b. 9000c. 10000d. 11000

11. Define Indemnity.a. The financial relationship between the insured and subject matterb. The right to claim from third partyc. The duty of disclosure of all material factsd. Putting back the insured in the same financial position before the loss

12. What are the options available to provide Indemnity?a. Paying cashb. Repairc. Reinstated. All of the above

13. Who has the authority to choose the option of indemnity?a. The policyholderb. The third partyc. The insurance companyd. None of the above

062 063


14. The difference between ‘Indemnity only’ cover and ‘Reinstatement’ or ‘New for Old’ cover is:a. In reinstatement there is no deductableb. In indemnity there is no depreciationc. In reinstatement there is no depreciationd. In reinstatement there is large deductable

15. Following a claim insurers pay SR100,000 to the policyholder and allow him to keep the salvage valued at SR10,000. How much can they claim from the third party?a. 10,000b. 90,000c. 100,000d. 110,000

16. A loss agreed at SR10,000 but after allowing for the deductible insurers pay SR 9,000 to the insured. How much can insurers claim from the third party? a. 1000b. 9000c. 10000d. 11000

17. What principle does Contribution and Subrogation support?a. Insurable interestb. Indemnityc. Proximate caused. Utmost good faith

18. Proximate Cause is the:a. First causeb. Last causec. Main caused. Physical cause

19. What is the purpose of Proximate Cause?a. To determine the indemnity amountb. To determine the deductablec. To determine if the loss is coveredd. All of the above

Module 3:Risk Underwriting


- Understand the proposal form- Identify the three main function of an underwriter- Understand what is a warranty and deductable- Describe the role of surveyor- Understand the maximum probable loss and relation to reinsurance

IntroductionIt is the duty of the underwriter to decide whether to accept a risk and if so on what terms. In this module, we look at the steps taken by an underwriter and how he gathers information in order to reach that decision.

Previous modules discussed the duty of utmost good faith, the importance of material facts and explained physical and moral hazards. In this module we refer again to these subjects, place them into a practical context and their importance to the underwriter when he assesses the risk.

The use of proposal forms, brokers’ slips and surveys to obtain information are considered. Finally, we look at how an underwriter presents a quotation.

066 067


3.1 - Material facts

It is the job of the underwriter to decide whether to accept a risk for insurance and if so he must then decide the applicable terms and conditions. In order to do this he needs all material facts.

See Module 2: Legal principles of insurance; Section 2.1 for a more detailed discussion of Material facts.

Do you remember the definition of a material fact?

A material fact is any fact that increases the risk or makes it more hazardous than others in a similar category. It is also any fact that has a bearing on the morals or character of the insured or his manager or employees

Without all material facts, the underwriter is unable to fully assess the risks presented to him. The importance of material facts in the insurance contract cannot be underestimated and failure to disclose will have serious consequences.

What are the options available to an insurance company who subsequently discovers that their insured has failed to disclose a material fact?

The duty of disclosure applies equally to both proposer and insurers but the duty is more onerous for the proposer who must disclose all material facts without being asked. In practice, although this may not be a problem for a larger commercial organisation, clearly an individual taking out insurance for the first time cannot possibly know those facts an underwriter would consider material and those which are immaterial.

066 067


Insurance companies therefore ask the appropriate questions, typically in a proposal form to obtain those facts they consider material. The point remains however that without full disclosure of material facts it is not possible to accurately assess the risk. If a proposer is in any doubt as to whether a fact is material or not the advice must be to disclose the information.

2.1 listed types of fact that the proposer must disclose and types of fact that he need not disclose. For ease of reference, those lists are repeated here.

Facts requiring disclosure include:• A full description of the subject matter of the insurance• Any other policies covering the same risk• Previous insurances• Details of previous losses and insurance claims• Any fact that increases the risk from normal.

Facts not requiring disclosure include:• Facts of law• Facts of public or common knowledge• Facts that lessen the risk• When further information has been waived.

In deciding whether a fact is material or not the type of insurance is relevant. The age of the proposer is material for life assurance (older person) but is not relevant to fire insurance on a building.

068 069


Using the above as a guide decide, giving your reasons, whether the following facts should be disclosed or not.

Age of the proposer (Motor):

Existing medical conditions (Medical Expenses):

Installation of a new fire sprinkler system (Fire):

Age of the proposer (Fire):

Outstanding loan on a car (Motor):

Type of stock (Theft):

Distance from the nearest police station (Fire):

The proposer’s claims record (Motor):

3.2 - Physical and Moral Hazards and the use of Warranties

After gathering the material facts the underwriters’ first decision is whether to accept the risk or not. Some types of risk, possibly because of a particular trade or type of property or location may be unacceptable to an individual underwriter.

If the risk is acceptable, the next decision of the underwriter will be to decide on the terms he will offer. In making this decision the underwriter will consider the physical, morale and moral hazards presented by the risk.

See Module 1: Risk and Insurance; Section 1.7 for a more detailed discussion of Moral and physical hazards.

068 069


070 071


Explain hazards and the difference between physical hazard, morale hazard and moral hazard.

In deciding terms, the underwriter must ensure that the insured makes a fair and equitable contribution to the common pool. The underwriter will have an average rate for a particular risk, often referred to as the ‘book’ rate based on the many years experience of underwriting that particular class of business. To this book rate, he will make adjustments to take into consideration the good and bad features of a risk.

As an example, the fire book rate for office building is 0.1% but if a particular building has a car parking area, with a small workshop where the insured stores petrol. The storing of petrol is clearly hazardous for fire insurance. To take this risk the underwriter might increase the rate, to say 0.15%. However, if the building has adequate fire extinguishers the underwriter might then reduce the rate, by say 10% making the net rate 0.135%. By adjusting the rate, the underwriter makes allowances for the bad and good features of a risk.

The underwriter, therefore, adjusts the rate of premium to recognise the differences that an individual risk has from the standard or normal risk for that class and consequently the contribution the insured makes to the common pool. The terms, however, are not just the premium to be paid. There are occasions when no amount of additional premium will compensate for a bad risk. Another option available to the underwriter is to impose an excess (also known as a deductible).

An excess is the first amount payable by the insured towards any claim. The insured pays for any claim up to the specified amount of the excess and the excess is deducted from all claims that exceed it.

If a loss is agreed at SR750.00 but there is SR100 excess then the insured will receive SR650.00 (750-100 = 650). A loss of SR 75.00 will be borne by the insured himself because it is below the excess.

070 071


A policy has an excess/deductible of SR 2,000. How much will the policy pay for the following claims?

a) SR 500 b) SR1, 500 c) SR 2,100 d) SR10, 500

Excesses are particularly useful for eliminating small claims, which can be administratively expensive to deal with and of course, the excess reduces the size of all claims, even large ones.

If the underwriter decides to impose the excess as part of his terms for accepting the insurance, this is called compulsory excess. There are occasions, especially for personal insurances when the insured may request an excess in return for a discount from the premium. This is known as voluntary excess.

In trying to ensure that the insured makes a fair and equitable contribution to the pool of premiums for the risk introduced the underwriter can amend the premium rate and decide whether to apply an excess as part of the terms for accepting the risk.

There is a third option - that of imposing a warranty on the insured.

The use of warranties by an underwriter is a valuable part of his overall terms. It enables him to ensure that good features of a risk are maintained throughout the period of a contract. It is also valuable in controlling poor physical hazards.

The office building referred to earlier had petrol stored in a small workshop. The underwriter may decide he wants to limit this hazardous feature of the risk by restricting the amount of petrol kept on the premises. He will do so by including the following warranty in the policy: -

It is warranted that the quantity of petrol in the workshop other than in parked vehicles shall not exceed 50 litres at any one time.

072 073


The insured received a discount on the rate because of his fire extinguishers. The underwriter will want to ensure that these are working satisfactorily and are in place throughout the insurance period. He may therefore include the following warranty:

It is warranted that fire-extinguishing appliances kept on the premises are maintained in efficient working order during the currency of this policy.

In the event that the insured breaks either of these warranties (by exceeding 50 litres of petrol or if the fire extinguishers are not maintained properly) the insurance contract itself is jeopardised.

A warranty is a condition written specifically into an individual policy stating that:

• Either a certain state of affairs does or does not exist Or• That something shall or shall not be done.

The warranty when applied to insurance contracts is a condition that goes to the heart of the contract. Insurers consider a breach extremely serious and a breach of a warranty makes the whole contract avoidable at insurer’s option.

A breach can reflect the attitude of the insured that ignores or breaks rules that can lead to physical damage. Therefore, a breach could allow insurers to avoid payment under a policy even if the breach is not relevant to the loss suffered. If our office owner keeps too much petrol or fails to service his fire extinguishers, his insurance contract will be in jeopardy.

However, unless there are other factors involved most reasonable insurance companies do not avoid paying claims when the breach has no connection to the cause of the loss.

072 073


Breaching a warranty gives insurers the option to repudiate a claim and possibly cancel the whole contract. Insurers rarely enforce the option to cancel but why do you think the penalty for breaching a warranty can be so severe?

The underwriter when assessing the risk wants to ensure that the insured makes a reasonable contribution. He also needs to ensure that any hazardous features of the risk are under control and good features maintained. The main terms that he can use to achieve these objectives are the premium, excess and warranties.

Far more difficult for the underwriter is the assessment of moral hazard. In an individual risk, it is the conduct of the person insured. The dishonest person who may make a fraudulent or exaggerated claim clearly presents a greater moral hazard than the honest person. However, recognising this in advance can be difficult and so can the decision whether an exaggerated claim is dishonest or merely a negotiating tool.

In addition to the individual, social attitudes can be important. There may be sectors of a society that, possibly because there is no personal victim, do not regard cheating insurers as dishonest.

Morale hazard in a business organisation can be recognised by the attitude of management and employees. Premises that are untidy, lack supervision or where the insured ignores safety rules suggest an attitude from management or employees that they will not respect the insurance rules.

There is an overlap between morale and physical hazard as poor morale hazard may lead to increasing the physical hazard that can cause or increase the size of a loss. A no smoking rule not enforced can lead to a discarded cigarette starting a fire. Untidy premises can cause accidents and injuries to employees or visitors. Safety rules leading to overcrowding or machinery not guarded correctly can cause damage. The losses are physical but all originate from the insured’s attitude and poor morale hazard.

074 075


A motor proposal form indicates that the proposer has a history of minor accidents. Could the cause of these accidents be poor morale hazard?

3.3 - Proposal forms and broker’s slips

Offer and acceptance are essential ingredients in an insurance contract.

The proposal form is the most usual way the offer is made by the Insured and the insurance company obtains information about the risk. They are usually designed in order to present the information in a convenient and easy to understand format that can speed up the underwriter’s work. They will provide information concerning the physical hazards and clues as to the moral hazard.

There is a variety of proposal forms issued by all companies covering a whole range of policies and therefore their look and appearance can differ greatly. Questions however, usually fall into two types those that that are general in nature, name, address etc and those that relate to the insured risk. We shall categorise proposal forms between personal insurance and commercial insurance.

Personal policies are those issued for individuals e.g. private car, house, travel etc. General questions will relate to the proposer and will include:• Name, age, address, occupation• Details of previous insurance policies• Details of previous losses or claims• Whether any other insurance company has refused to give cover

The answers to these questions will help to build up a ‘picture’ of the proposer.

Other questions will refer specifically to the type of insurance. Examples include:

074 075


Private Car• Vehicle details• Driving experience of proposer• Details of other drivers• Use of the vehicle

House Insurance• Location of property• Value• Construction

Commercial policies are those issued for businesses. General questions may include:

• Business name and postal address• Business locations• Exact description of trade• Details of previous insurances• Previous losses and claims

Examples of specific questions include:

Third Party/Liability Insurance• Contracts entered into• Estimated turnover or sales• Limit required• Details of any machinery used

Theft • Nature of goods• Details of locks, bolts etc• Value of goods• Unoccupancy times of premises

After completing the form, the insured will sign and date the form. As part of the form, he will also be signing a declaration at the foot of the form. The declaration is an important part of the form as it confirms that the information supplied by the proposer is true and correct usually to his best knowledge and belief.

076 077


Many proposals also contain a warning regarding the duty of disclosure. It may be part of the declaration or more prominently included on the form. The note contains a warning as to the importance of disclosing all material facts, defines a material fact and suggests that if the proposer is in any doubt as to whether a fact is material or not he should disclose it.

Whilst the majority of insurances require the completion of a proposal, there are times when they are not used. In larger fire risks, the details may be so complex that it would not be possible to provide all details in a single form. Many insurers therefore do not use them, whilst others will always ask the insured to sign the form as it includes the declaration.

A proposer submits a proposal form with all questions properly answered. He encloses full payment of the premium and requests that cover starts immediately. You note that the proposer has not signed the form. What action would you take?

Marine insurance developed at Lloyd’s of London and the practice at Lloyd’s is not to use a proposal form but for the broker to present details on a broker’s slip. Today, apart from small pleasure boats it is not common practice to use proposal forms for marine insurance.

The use of the broker’s slip has grown and it is now usual for brokers to present larger commercial business to insurers on a slip. The broker a is full time insurance professional and is aware of the information needed by the underwriter to prepare a quotation. The broker’s slip will contain all the necessary details including possibly even a guide to the rate and conditions they expect.

A simple broker’s slip for the previously mentioned office building may look as follows:

076 077


Professional Insurance Brokers Ltd Quotation Slip

Proposer ABC Property Company Business Building OwnersPeriod of Insurance 12 months from 1.1.2002Cover required FireLocation 125 High Street, AnytownSum Insured SR100MDescription 5-storey office block built 1995Occupation Rented as offices to some 10 tenantsPrevious Claims NonePrevious Losses NoneOther Information Underground car parking for 50 cars Includes storage area for petrol Fire extinguishers located on each floorRate Please adviseCommission Normal terms apply

If the business is accepted, insurers may choose to accept the slip and dispense with the requirement of a proposal. When presenting the information the broker is acting as the agent for his client.

A broker’s slip states that the insured has never suffered a previous loss. The insurance is prepared based on the information contained in the slip. Later the investigation of a claim reveals that the insured has had previous claims, although he states that he advised the broker. What is the position of:a) The Insurance Company

b) The Insured

c) The Broker

078 079


3.4 - Surveys

In respect of a simple personal insurance a proposal form may provide sufficient information to enable the underwriter to assess the risk and make his decision as to whether to accept the risk and if so the terms to apply. For larger risks and where possible for the majority of commercial insurances a survey is required.

The surveyor is often referred to as the eyes and ears of the underwriter, he will visit the premises to be insured and complete a report to be submitted to underwriters to assist him to assess the risk.

The reasons for requesting surveys include:• To obtain a full description of the risk. Particularly if the proposal is

inadequate for this purpose.• To check that the details on the proposal are correct.• Assess the physical hazards.• Assess the morale hazard. Looking for such features as employee

attitude, tidiness, and cleanliness.• Recommendations on risk improvement and loss prevention.

The shape of the report will depend largely on the complexity of the insurance. An insurance company may have pre-printed short survey forms covering most lines of business for smaller risks. The surveyor will simply complete this in much the same way that the insured completed his proposal form. For larger risks, the surveyor may need to prepare a written report. Whether it is a lengthy printed report or a short form the information in the report will contain the following:

• A full description of the risk. This may include a plan of the premises, photographs, type of work undertaken, details of neighbouring buildings.

• An assessment of the level of risk, taking into account all the physical and morale hazards.

• An opinion on the management or housekeeping at the insured’s premises.

• Recommendations on loss prevention.• Adequacy of the insurance requested to ensure that it is reasonable

and not too high (over insurance) or too low (underinsurance).

078 079


Underinsurance is a problem for insurers because it means the insured is not contributing sufficient funds to the common pool for the risk he is introducing. Slight over insurance is being cautious but insurers view excessive over insurance with suspicion. Why do you think this is so?

The underwriter’s job is in three parts. We have already discussed two of them (first whether to accept a risk and then the terms), the third aspect is how much of the risk to retain for his account and how much to reinsure. To help make a decision he will rely on his surveyor’s opinion of the worst possible scenario; the maximum loss that can be suffered from one single event.

This maximum loss from any one event is the MPL (Maximum Probable Loss) or sometimes the EML (Estimated Maximum Loss). It is a very important figure to enable the underwriter to complete his job and an important aspect of the surveyor’s report is his opinion on the amount of EML.

The sum insured is insurer’s maximum liability and they can never pay more than this amount but the EML may be lower than this. If for example, the insured owns two buildings each insured for SR1M then the total sum insured and insurer’s maximum liability is SR2M. However, if the two buildings are in separate locations, insurers cannot suffer a total loss on this policy from one event: a single fire cannot destroy both buildings. The surveyor may estimate the EML at SR1M. The underwriter will decide his retention based on the EML of SR1M and not the total sum insured of SR2M.

The EML is important in deciding the reinsurance arrangements. If the surveyor estimates the EML too high then the insurers will retain less risk than warranted and reinsure the balance thus paying more towards reinsurance premiums. If he estimates it too low then insurer will retain more than warranted i.e expose themselves to a higher risk and possibly a claim in excess of their capacity though reinsurance outgo will be less.

080 081


An insured owns a building valued and insured for SR10M. He advises that he has purchased the neighbouring building that is identical. He adds the second building to his policy making two buildings each insured for SR10M and a total sum insured on the policy of SR20M.How do you think this will affect the rate? Will it: a) Increase b) Decrease c) Stay the sameGive reasons for your answer

An underwriter’s job is in three parts. What are they?

3.5 - Quotations

On receipt of all the facts, an underwriter is in a position to assess the risk. He will decide his terms and the next step to effecting cover is to offer his terms to the proposer as a quotation. The proposer or his broker may have approached several insurance companies for quotations.

The quotation by insurers is an offer that if the proposer accepts creates a contract. It is important therefore for the underwriter to prepare his quotation accurately, as it may be difficult to alter or correct any errors at a later stage.

If the proposer accepts the quotation then insurance cover is in force from the inception date required on or after the date of receipt of premium. However, circumstances change and a quotation must be valid for a fixed period, typically 30 days but could be less. At the end of this time, the quotation is invalid and the underwriter has the opportunity to change the terms.

080 081


What could the consequences be if an insurance company issued a quotation with no date and no time limit?

It must be emphasised that there is no cover in force during the period of the quotation. This is simply the time allowed for the proposer to decide whether to accept the underwriter’s quotation.

If the quotation is acceptable, cover will be in force from the required date and insurers will make steps to issue a policy. This may take several days but cover is in force during this period. The policy is the written evidence of the contract; it is not the contract and is not a prerequisite for insurance.

If the insured requires evidence of the insurance, perhaps for a contractor, bank or employee then insurers issue a cover note. This is a document confirming that cover is in force. It may be a simple letter from insurers or a more formal document. Once the policy is prepared and issued, the cover note is no longer necessary.

To prepare the quotation accurately would require a completed proposal form and a survey but for commercial reasons insurers may need to prepare quotations before these are completed. The underwriter will prepare the quotation but with conditions attached.

The underwriter will offer the quotation but ‘subject to completion of a satisfactory proposal’ and if, the underwriter feels the risk requires a survey (almost certainly for any reasonable sized commercial risk) he will add ‘subject to completion of a satisfactory survey’.

082 083


A quotation for ‘office’ owners could look as follows:

New World Insurance Co LtdTo: Professional Insurance Brokers LtdDate: 5th December 2001Quotation No 1234/ABC

Proposer ABC Property Owners LtdBusiness Building OwnersPeriod of Insurance 12 months from 1.1.2002Cover required FireLocation 125 High Street, AnytownSum Insured SR100MDescription 5-storey office block built 1995Occupation Rented as offices to some 10 tenantsPrevious Claims NonePrevious Losses None Fire Rate .135%Rate Subject to 1. Satisfactory Proposal Form 2. Satisfactory Survey Warranties 1.Max 50 litres petrol (excl in parked cars) 2. Fire appliances serviced and maintainedCommission Standard

Quotation Valid for 30 days from date of issue

If the subsequent survey or proposal reveals any unsatisfactory aspects, the underwriter has an opportunity to change his terms. If the insured asks for immediate cover i.e. before the proposal or survey is completed, the normal practice is to hold covered but again subject to the proposal or survey being satisfactory.

082 083


An insurance company issues a quotation that the proposer accepts. Insurers issue the policy and later the insured submits a claim. Realising they have no proposal the company request one. On arrival, there are several unsatisfactory features.

Do you think insurers have any grounds for refusing to consider the claim? What should they have done?

Write your answer here.

084 085



1. If the insurance company surveys the premises this will:a. relieve the insured of the duty of good faithb. lower the deductablec. lower the premiumd. none of the above

2. Which of the following is not a material fact in relation to comprehensive motor insurance?

a. Chassis number b. Make and model of the vehicle c. Value of the vehicle d. Number of children the proposer has

3. Which of the following documents provides an underwriter with a fast, effective and convenient method of obtaining material facts?

a. Quotationb. Proposal Formc. Policyd. Certificate of insurance

4. An insurer issues a quotation on 15th January, which the insured accepts with cover to commence on 1st February. A loss occurs on 29th January but the insured does not inform the company as the loss happened before cover started. After paying the claim, the insurers discover that the loss occurred before inception.

What action can insurers take?a. No action cause they already paidb. They can ask the insured to pay back the claim to themc. Cancel the policyd. None of the above

5. Why do insurers use warranties?a. To decrease the deductableb. To control bad hazard and maintain good onesc. To determine the premiumd. To determine the conditions

084 085


6. What is the difference between a voluntary excess and a compulsory excess?

a. Voluntary excess is chosen by the policyholder while compulsory by the underwriter

b. Voluntary excess is chosen by the underwriter while compulsory by policyholder

c. Compulsory excess is more than the voluntaryd. There is no difference

7. The main function of the surveyor is to:a. Decide the premiumb. Put the warrantiesc. Visit the site to be insured and report to underwriterd. Give advices to reduce the risk

8. EML (Estimated Maximum Loss) is:a. The maximum loss in one yearb. The maximum loss in one claimc. Less than the sum insuredd. Greater than the sum insured

9. When does insurance cover commence?a. During the period of the quotationb. After paying the premiumc. After accepting the quotationd. From inception date after accepting the quotation

Module 4:The Insurance Market


- Discuss the operation and structure of insurance market- Identify the different types of insurance companies- Identify the different types of intermediaries- Identify the types of insurance buyers- Outline the different distribution channels used for buying and selling of insurance

088 089


IntroductionA market is broadly defined as a place where buyers and sellers meet to exchange goods and services. Insurance is a market and although there may be no physical meeting place it is still a market where buyers and sellers are brought together often with the assistance of intermediaries.

In this module, we shall examine the structure of the insurance market and the different groups of buyers, sellers and intermediaries that together make the market place. Reinsurers’ role in the market is also considered

Finally, we shall look at the role played by other parties who supply a service to the insurance industry.

088 089


4.1 - Components of the insurance market

A market is where buyers and sellers meet to conduct business but this does not necessarily have to be a physical meeting place. Modern technology has made communications between parties much easier and business is done at a time and place more convenient to everyone.

The insurance market includes three publicly known groups with a fourth group known primarily by those within the industry.

The three publicly known groups are the buyers of insurance, the intermediaries (middlemen), and the sellers of the service, collectively known as insurers. The fourth group are the reinsurers who support insurers.

In this section, we shall become familiar with the sellers or providers of insurance, the insurers. The most well known are insurance companies, who provide insurance to the public. These are classified according to their ownership structure or type of business written.

Proprietary Companies Shareholders who have either supplied the share capital or purchased shares in the company own proprietary companies. It is to the shareholders that any profits belong, in the form of dividends. The shareholders would however endure the cost of any losses and could lose their entire investment.

Mutual CompaniesPolicyholders own mutual companies and who share any profits, usually either a bonus (mainly life assurance) or lower premiums for other types of insurance.

Specialist/CompositeA specialist insurance company (either mutual or proprietary) is, as its name implies one that specialises in a particular class of business. A composite company on the other hand is one that deals with all, or certainly the majority of classes of business.

090 091


Let us take a look at the concept of self –insurance, when a business will make a conscious and deliberate decision to retain risk for itself. In order to facilitate this process a business enterprise may form a captive insurance company.

A parent company, typically a substantial national or multi-national organisation, will form a subsidiary captive insurance company to insure its own risk. Originally, designed as a tax efficient method of retaining risks, though many of the original tax incentives have closed they are still a very popular method of self-insurance for a company.

The captive insurer is not registered as an insurance company (even though it may have the title in its name) and cannot do business with the public. Trading sectors of the parent company pay premiums to the captive who issue policies and deal with claims as a commercial insurer. Like a commercial insurer, it will also protect its fund by using reinsurance.

Lloyd’s of LondonA unique institution Lloyd’s began as a marine insurer in the 1600’s. At that time, Edward Lloyd’s coffee house in London was a meeting place for people generally interested in shipping that gradually became a centre for marine insurance. They increasingly wrote other classes of business and in 1871, Lloyd’s Corporation was set up to govern and administer their affairs.

Lloyd’s is not an insurance company and does not itself transact business. It provides the facilities (building, administrative support etc) for its members who transact business. For many years, these were individuals, operating on an unlimited liability basis, who formed themselves into syndicates. The syndicate would appoint an underwriter to accept risks on behalf of the syndicate. At one time Lloyd’s had some 30,000 individuals (known as names) grouped into some 400 syndicates.

Following a series of disasters in the 1980s and early 1990s, a large number of these names lost their life savings. In some cases, family fortunes built up over several generations were lost. Since that time the number of names have reduced and Lloyd’s have allowed corporate members with limited liability to join.

090 091


It is a feature of Lloyd’s that it does not deal directly with members of the public. They only accept business from Lloyd’s brokers (insurance brokers who have been approved by the Council of Lloyd’s) and only Lloyd’s brokers are permitted on to Lloyd’s trading floor (known as the ‘room’)

Lloyds website: www.lloyds.com

The StateIn many territories the state will also act as an insurer. This may be because insurance is a nationalised industry or where the state has declared a certain type of insurance compulsory (workmen’s compensation or third party motor for example) and then insures that class of business.

There are several other examples of types of insurers but these are formed due to legislative or tax consideration in particular countries. Friendly Societies, Mutual Indemnity Associations, Industrial Life are examples from the UK of insurers who exist because of a tax and legislation advantages.

In any typical market place, sellers compete with each other for business. Think of a market with which you are familiar e.g. local vegetable market, a market for consumer goods, say a TV or newspapers. List the various methods that the suppliers of these goods use to attract customers.

Now consider the suppliers of insurance. Do they use the same methods you have outlined above or do you think there are differences?

Buyers of InsuranceBuyers of insurance are usually classified into two broad groups, private individuals and commercial organisations. The needs of each group are different and the types of policies arranged for each group are different.

092 093


Private individuals usually referred to as personal insurances or personal lines and the bulk of the market is in respect of private motorcars and houses insurance.

Other insurances in this sector include travel, life and personal accident. Individually the premiums are not large but together the personal lines market can produce a large volume of business.

It is however the commercial sector that supply the bulk of the premium income for insurers. Most insurance companies are organised on the lines of personal and commercial with possibly the commercial sector sub-divided according to size or type of insured.

A third category occasionally used is that of public bodies or not for profit organisations. These organisations provide a public or voluntary service, charities, government departments, schools, hospitals, sports clubs etc.

What do you think is the advantage to insurers of classifying buyers into personal and commercial?

4.2 - Intermediaries

IntroductionIn general, the term agency describes a situation when one party (the principal) authorises another party (its agent) to act on its behalf. The rights and duties of each party are subject to the law of agency. In insurance, the term agent has a different meaning and therefore to avoid confusion between the insurance agent and the general law of agency it has become customary to use the term intermediary when referring to insurance.

092 093


It is quite possible and in many cases quite common for buyers to go direct to an insurance company and purchase insurance. They will consider and decide their insurance requirements, find the correct insurer and negotiate accordingly. Others may decide they need someone to act on their behalf, provide impartial advice, and consequently visit an insurance intermediary.

The intermediary is a middleman whose role is to bring buyers and sellers together into a contractual relationship. He receives payment in the form of commission deducted from the premium that is payable to the insurer. Although insurers pay the commission and it is with insurers that he may have a close and long term professional relationship, it is the insured who is the client and the insured for whom the intermediary is acting.

One of the problems when considering the intermediary sector of the market is its fragmentation, with a variety of people doing the role and many with different titles although they may be effectively doing the same job. Brokers, consultants, agents and advisers are titles intermediaries may call themselves. Some countries have tried to regulate this sector of the market by using legislation to control who may use titles or who may perform certain functions.

Intermediaries in KSAThe implementing regulations of the Saudi Arabian Cooperative Insurance Companies Control Law have defined the participants in this sector into three types.

SAMA is still introducing the regulations and their impact on the structure of the market is unknown. Before the regulations, it was a fragmented sector comprising Brokers, Agents, Consultants and others, many of whom are professional but others less so and simply using the title to give themselves status. Within the industry professional could recognise each other but to the insuring public their competence is unknown.

094 095


BrokersTraditionally an insurance broker is an individual or firm whose full time occupation is insurance. Use of the term broker implies that they are holding themselves out to be experts in insurance. They are knowledgeable about insurance and can give independent and impartial advice to a policyholder on their professional needs. They know the insurance companies in the market and which offers the most appropriate product for their client’s need at the most favourable terms. In KSA there are local companies operating nationally often with international connections and they compete with multi-national companies who operate in many territories and employing several thousands of staff. The larger multi nationals have in excess of 50,000 employees, over 500 offices in more than 120 countries and enjoy revenues in excess of US$8Billion. The regulations make it clear that a broker is representing his client whose interests should be of primary importance. Agents Traditionally an insurance agent is either a full time sales person representing a single insurance company or a part time insurance salesman who has other business interests that provided an opportunity to sell insurance. Typical would be the car dealer who sells a car and insurance to go with it. Estate agents, accountants, legal personnel are other examples. These part time agents normally confine their activities to introducing the business; they do not claim to be experts in insurance and will not offer guidance except in the most general way The new regulations make it clear that an insurance agent represents the insurance company and can only give advice on, or recommend the products for that one company. AdvisorThe regulations introduce the advisor as someone who provides consultative services. Brokers and agents receive a commission on the products they recommend to the policyholder but it appears that this category of insurance service provider will be paid by charging a fee, based on the service provided for giving consultation and advice that may not necessarily result in the purchase of an insurance product.

094 095


Your friend has asked your advice about buying insurance. He wonders if there is any advantage in visiting a broker. What would you reply?

4.3 - Distribution channels

The distribution channel of a product describes the methods used to bring a product from its manufacturer to the final consumer. In insurance, the ‘manufacturer’ is the insurer and in order to distribute his product there are two principal routes; either, direct to the consumer or indirect, using intermediaries. Each has their benefits and drawbacks. Some companies prefer to deal with one method exclusively whilst others use a combination of the two.

Direct Business:Direct business involves the insurer selling his product direct to the insuring public without any independent intermediary being involved.

A traditional method of direct selling is to employ a direct sales force and although paid on a ‘commission only’ basis, they are employees of the company. This system is very popular especially with life assurance.

There has been a great expansion of direct business in the last decade or two mainly in personal lines business. Improvements in communications and the use of computers makes it possible to do business from a central processing office (a call centre) with quotations and cover given instantly over the telephone. These direct companies pay no commission but need to advertise heavily. This type of business is mainly suited to personal lines insurance, primarily car and house insurance.

096 097


Indirect Business:Intermediaries introduce business to the insurance company in return for which they receive commission. The insured receives the benefit of independent and impartial advice from the broker who will place the business with the company that offers the best terms and conditions for his client’s business. The broker may also assist his client in dealing with claims or any other problem with the insurance. Intermediaries, usually insurance brokers arrange the majority of commercial business.

The insurer will have to pay commission to the broker but has no major advertising expense. The relationship with the broker can be long standing and because the brokers are themselves professionals, insurers can entrust a great deal of the administrative work to them.

Many brokers do not wish to handle too much personal lines insurance, as the individual premiums can be relatively small for work involved. With the improvements in technology, the trend has been for personal business to be handled direct and commercial insurances indirect. This trend may continue as the future makes communication easier in the form of WAP mobile telephones, Interactive Digital TV, the Internet and whatever else the future may bring.

Why do you think that direct business is more suited to personal lines insurance e.g. private car insurance than to commercial business?

ReinsuranceReinsurers are part of the supply chain as they support and extend the supply of insurance. They accept business only from insurers, i.e. insurance companies (including captives), Lloyds and other reinsurers, often dealing through an intermediary, the reinsurance broker.

096 097


Reinsurers may be a specialised reinsurance company i.e. they do not transact business with the insuring public. Insurance companies also act, as reinsurers, through either a separate division or subsidiary company. Lloyd’s syndicates are also active in reinsurance.

Reinsurance also has a ‘jargon’ of its own such as retrocession, cedant, ceding office. (See Glossary for explanation of these terms). Reinsurance is an international business and risks shared in many parts of the world by co-reinsurers are spread over several reinsurance companies.

Insurance operates because it shares the losses of the few by the many by transferring risk. How does reinsurance fit into this broad concept?

4.4 The role of ancillary players in the insurance market.

We have looked at the insurance market and the various roles of the parties involved in the industry - the buying public, intermediaries, insurers and reinsurers. There are also other businesses working in the industry, not directly involved with the supply of the product but providing services and support to the industry. We shall consider the principal ones.

Actuary Actuaries use mathematical and statistical techniques to solve business problems by predicting future events. They have been used in life assurance for many years but are more and more being used in general branch insurance.

Companies may employ actuaries or use the services of an external actuarial consultancy company.

098 099


Loss Adjusters Loss adjusters are employed by insurers to handle and process claims on their behalf.

Some companies employ loss adjusters to handle the majority of their work and others prefer to handle all claims internally. However, even these companies will need the services of a loss adjuster at some stage either for a particularly large claim that requires detailed investigation and negotiation or when there are a large volume of claims to be dealt with.

A loss adjuster specialises in insurance claims. He will investigate the cause of the loss, check that policy conditions have not been breached, negotiate with the insured and make a final recommendation, which should be fair and reasonable to both the insured and insurers, for settlement.

Loss adjusters hold themselves to be independent but insurers who appoint them pay their fees.

Loss AssessorsLoss assessors are appointed by the insured to prepare, present and negotiate a claim on their behalf.

It is the duty of the loss assessor to negotiate the maximum entitled settlement under the terms and conditions of the policy and to provide support to the claimant during the processing of a claim. He is paid by the insured usually based on an agreed percentage of the final settlement.

As far as it is known, there are no loss assessors operating in the Kingdom although the service of assisting in the preparation, presentation and negotiation of a claim may be offered by some intermediaries.

Risk Management:Industry and commerce employ risk managers although insurance brokers may offer a risk management service on a fee basis. There are three steps in risk management, first risk identification followed by a risk analysis and finally risk control.

098 099


The first stage is to identify the risks that a business enterprise is exposed. This could be physical, financial or monetary. Having identified the risk, it will be analysed possibly using past data, examining the frequency and severity profiles, and trying to predict the future outcome. Finally, the risk manager will try to control the risk preferably by eliminating it (e.g. changing work practices) reducing it (locks and bolts to prevent theft) or by transferring it (insurance).

Risk management and insurance are closely linked but insurance is only one option available to a risk manager when deciding on risk control.

Insurers employ loss adjusters to investigate claims and loss assessors by policyholders to prepare and present a claim on their behalf. They operate in only area i.e. they are either a loss adjuster or loss assessor. It would be unusual for one business or person to work in the area of the other. Why do you think this is so?

100 101



1. The company owned by its shareholders is a a. proprietary companyb. mutual companyc. reinsurance companyd. captive company

2. The company who insures insurers is aa. proprietary companyb. mutual companyc. reinsurance companyd. captive company

3. The company that distributes its surplus profits to its policyholders is known as a

a. proprietary companyb. mutual companyc. reinsurance companyd. captive company 4. The company that does not provide insurance to the general public is

called a a. proprietary companyb. mutual companyc. reinsurance companyd. captive company

5. What is the difference between a specialist company and a composite company?

a. Specialist deal with one type of insurance while composite in manyb. Composite deal with one type of insurance while specialist with one

typec. Specialist cannot be mutuald. Composite cannot be captive

100 101


6. What is the difference between a broker and an agent?a. Broker deal with one insurance company while agent with manyb. Broker deal with many policyholders while agent with onec. Broker deal with many insurance companies while agent with oned. Broker deal with one policyholder while agent with many

7. Insurance may only be placed at Lloyd’s through a Lloyd’sa. Agentb. Underwriterc. Loss adjustord. Broker

8. An insurer doing only direct business will claim to have lower costs because;

a. They pay no commission b. They do not advertise c. They pay lower salariesd. They take less reserves

9. A loss adjustor:a. Assesses the financial impact of future uncertain eventsb. Investigates claims on behalf of insurersc. Prepares and presents a claim on behalf of an insuredd. Advises a manufacturer on safety and loss control

Module 5:The Need for Documentation


- Describe the content and structure of the policy- Understand the difference between a cover note and a certificate of insurance- Understand the importance of renewal invitations

104 105


IntroductionA contract does not have to be in writing to be a valid contract. However, in a complex matter such as insurance, it is advisable to have the details in writing. There is clearly an opportunity for disagreement if changes are not confirmed in writing. Documents serve several purposes including:

• Information: Standard documents are used, which help insurers receive information in a consistent manner. This reduces the possibility of receiving irrelevant data or missing important information.

• Record Keeping: Insurers need to know their potential liabilities, reinsurance requirements etc.

• Discrepancies: The documents clarify discussions and agreements and ensure that insurers satisfy the policyholder’s requirements

• Disputes: Reference to the appropriate document can often resolve disputes at an early stage.

The result is a range of documents for different purposes, which we shall examine in this final module. Several will be familiar as they were discussed in earlier modules. Others will be new to you.

104 105


5.1 - Proposal Forms and policy structure

Proposal FormsThe proposal form is the most convenient way for the insurer to receive information concerning the proposed risk. Proposal forms can be quite plain or can be a form of advertising, particularly for personal business.

See Module 3: Risk Underwriting; Section 3.3 for more detailed information on the Proposal forms.

A brochure helps to sell the product and the proposal when completed is detached and sent to the company. The policyholder retains the brochure for information purposes. Brochures may contain a note that the brochure is not part of the contract and is ‘for information only’. It is however advertising and like all advertising, it cannot mislead or misinform the client.

You will recall from module 3.3 that marine insurance and sometimes large and complex fire risks do not use proposal forms. Briefly, explain the reasons for this.

Policy FormsWhen the insurer has accepted the proposal, terms agreed, the premium paid (or the insured has promised to pay the premium) then the contract is in force and subject to the laws of contract, irrespective of the existence of a policy wording. The policy is the evidence of the contract, not the actual contract.

Every insurer has their own style of wording for the different classes of business they write. The approach and presentation may be decided by company policy, some are simple A4 format, others particularly for personal lines use a small booklet, bound in plastic covers or try to make them ‘user friendly’ with explanatory notes and glossy pictures.

106 107


The class of business determines the length of the document. A simple PA policy may be just a few pages but a house insurance with its numerous sections or a fire and perils policy for a large manufacturing risk, with extra perils, warranties etc could be quite a bulky document of several pages.

In the UK, the Plain English Campaign has had a major influence on insurers’ approach to policy wording. It has made them consider the structure, layout and language used and many policies try to use clear, everyday language and define any words that may be unfamiliar or capable of misinterpretation.

Whilst we have stated that every insurer has their individual style, all policies contain eight sections. They are:

Heading:The section at the top of the policy giving the insurer’s name, possibly the company logo and the registered address.

Preamble:Usually found immediately below the heading (which means a preliminary statement or introduction).

The preamble contains two essential points:• The proposal is the basis of the contract and the proposal form

incorporated in the contract. The proposal is not confined to just the proposal form. Other documents, correspondence, discussions etc are part of the proposal and therefore, part of the contract.

• Reference to the consideration of the insured (has paid or agreed to pay the premium) and the consideration of the insurer (will provide the insurance as detailed).

Operative Clause:An important section of the policy as it sets out precisely the cover provided by insurers and the circumstances when they will pay.

They often start with the phrase ‘The Company will pay’ and then the details follow. The Operative Clause can be very short, (certain All Risks Policies) or quite lengthy (a motor policy).

106 107


Why is the Operative Clause on an All Risks Policy much shorter than that of a named perils policy?

Exclusions:Also known as exceptions they detail what the policy does not cover. Exclusions can be classified into one of three categories:

• Risks considered uninsurable in the normal insurance market. Sonic bangs, radioactive contamination and war (on land) risks are three that are most common.

• To avoid confusion certain risks are more appropriately insured under another policy. The theft policy may exclude money; the PL policy excludes liability arising from the use of motor vehicles and so on.

• There are risks that insurers are prepared to consider but because they are extra hazardous, only after making further enquiries and possibly requesting additional premium and/or other terms.

Give an example of two exclusions: The first - because the cover is available under another policy The second - where the risk is insurable but excluded because it is an additional hazard for insurers

Conditions:All insurance policies are subject to conditions - either Implied i.e. not written in the policy or Express i.e. they are written in the policy. They lay down rules that govern the behaviour of both parties during the currency of the policy.

Implied conditions are present for all policies and they are:• That the subject matter of the insurance (property etc) actually exists

and is identifiable• That both parties have observed utmost good faith• That the insured has insurable interest

108 109


Written into and part of the wording are the express conditions. They vary according to the type of contract but several are common to most policies. Conditions can be general, which means they apply to the whole contract. These include:• Alterations• Cancellation• Claims Notification• Fraud• Reasonable Care• Subrogation• Contribution• Arbitration

If general conditions apply to the entire contract then particular conditions are conditions that relate to a particular or an individual section of the policy and not the entire contract.

Conditions vary according to the time they operate for example, some relate only to after a claim has occurred. There are three headings:

• Conditions before the contract These are mainly the implied conditions but may also be written into the wording. They operate before the contract is formed.

• Conditions after the contract These operate after the contract is in force and are the majority of the conditions. They include taking proper care, fraud, cancellation, alterations etc.

• Conditions before liability These conditions apply after a claim and if the claim is to be paid must not be broken. Subrogation, contribution (other insurances), claim notification are examples.

COOPERATIVE PROFIT SHARING CLAUSE:Ten Percent (10%) of said Net Surplus shall be distributed to all Policyholders, each proportionately to his premium, by reducing the premium of the following year.

Signature:The policy is signed by a senior official of the company, typically the managing director or general manager. The signature is printed on the policy and usually countersigned or initialled by the official checking the contents before forwarding to the client.

108 109


Schedule:The six sections of the policy discussed so far are a standard document for each type of policy. The policy forms are mass-produced and the schedule contains all the information concerning the individual risk that makes it an individual contract.

The schedule may include the following information;• Name of the insured• Postal address• Risk address• Description of business• Inception Date• Renewal date• First and annual premium• Policy number• Sums Insured• Description of property insured (if large a separate specification may

be attached)• Excess or deductibles• Special conditions• Name of broker or agent

5.2 - Warranties and endorsements

Warranties

See Module 3: Risk Underwriting; Section 3.2 for more detailed information on Warranties.

What is the definition of a warranty?

Some people argue that warranties are part of the policy conditions and not a separate section of the policy. The argument is academic; the main point is that a breach of warranty entitles the aggrieved party (nearly always the insurer) to repudiate the entire contract. In that sense they are more ‘important’ than the conditions where although

110 111


a breach might entitle insurers to repudiate the contract (e.g. fraud), many breaches of conditions may entitle insurers only to repudiate an individual claim (breach of subrogation condition) or to impose stricter terms (e.g. failure to declare a premium adjustment condition).

Despite the seriousness of a breach of warranty, insurers in practice tend to be more moderate in their approach and unless it is very serious do not repudiate contracts for a single breach. They would not wish to lose an otherwise good policyholder and it is unlikely that they would repudiate a claim if the breach were unconnected to the loss.

EndorsementsDuring the currency of a policy, changes are inevitable, the insured may change his motor vehicle, property owners buy and sell properties, values change, and items added to the schedule with others deleted. Insurers prepare an endorsement detailing the changes made to the terms of the insurance.

Typical of an endorsement is a change of vehicle under a motor policy. The insured advises insurers who if they are prepared to accept the change will advise the insured of any extra terms or conditions they may wish to impose. (It may be a vehicle with much higher value or performance). If the insured agrees to the new terms then an endorsement will make the change to the policy. The endorsement will note details of the new vehicles, any extra terms (higher excess) or additional premium that may be due.

5.3 - Cover Notes and Certificates of Insurance

Cover NotesThe policy is the written evidence of the contract and contains all the details of cover provided. Preparing the formal document takes time and it is not always possible, in fact, it is very rare for the document to be ready from the first day of the insurance.

In the meantime, the insured may need to show to a third party that insurance is in force. If property is security for a loan, the bank may insist on insurance or a contractor may need to prove insurance to his principal before commencing work. The cover note serves this purpose.

The cover note simply states that insurance is in force and gives brief details of the cover. The notes are temporary and not needed once the policy is

110 111


issued. The cover note may be a pre-printed form often in a numbered book or could take the form of a letter from the insured to the insurer.

Cover notes can be informal and vary between insurers as to content, style and appearance. They all, however, serve the same purpose - they are proof - if proof is needed that insurance is in force and insurers are preparing the policy documents.

Certificates of InsuranceCertificates of insurance serve a very similar purpose as cover notes; they confirm that cover is in force. When insurance is compulsory, the authorities may ask the insured to confirm that cover is in force.

It would be cumbersome to carry the entire policy document and as they differ from company to company, it would be difficult for the authorities e.g. the police to be sure that the policy was valid. Certificates are therefore required and they are in a standard format recognisable by all concerned.

Marine cargo insurance uses certificates of insurance and they become part of the shipping documents. The certificate of insurance contains information concerning the shipment which will be substantially the same as that contained in a policy i.e. description of goods, conveyance, voyage, sum insured etc.

Marine Insurance plays a vital role in the international system of trade and although not legally required the insurance policy together with letters of credit, bills of exchange, bills of lading, are necessary documents to facilitate the smooth exchange of goods and money around the world.

A vendor selling his goods overseas will naturally want payment for those goods when they leave his warehouse. A purchaser buying those goods will not wish to pay for them until they have safely arrived in his warehouse, possibly thousands of miles away. Journey times may take several months and there is clearly a problem if both parties are to be satisfied.

A step-by-step example will make the process clear.

1. Rashid in Riyadh agrees to purchase machine parts from a company based in Manchester, UK.

2. Rashid visits his bank in Riyadh and obtains a letter of credit.

112 113


3. The letter of credit is sent to the supplier’s bank in the UK.4. To obtain the money the supplier sends the goods to Riyadh and

confirms by giving the shipping documents including the certificate of insurance to the bank.

5. The UK supplier receives his money.6. The UK bank sends the shipping documents to Riyadh.7. The goods are in transit between UK and Riyadh8. The goods arrive.9. To collect his goods Rashid needs the shipping documents, to collect

these he needs to pay the bank in Riyadh.10. So the supplier gets his money from the bank, the bank collects the money

from the buyer and the buyer collects the documents from the bank and collects his goods. So every party is satisfied with the transaction.

The journey from the UK to Saudi Arabia could take several weeks. If there is a problem e.g. the boat sinks or an accident destroys the goods, the banks and/or Rashid have lost their money. Consequently, the banks will require a marine insurance policy to cover the goods during the journey. The certificate of insurance is an essential part of the shipping documents and is proof that a policy is in force.

As the certificate of marine insurance is part of the shipping documents if the goods change hands, the insurance certificate also changes hands with the goods. This is different from other classes of general insurance (non life) business. If a motorcar or a building is sold, the insurance is not sold with the property. The identity of the policyholder is an important underwriting consideration for insurers and they may not wish to give cover to the new owner.

Why do you think that a bank involved in an international transaction will insist on marine cargo insurance?

5. 4 - Claim Forms

Generally, policyholders notify insurers (or their brokers) of a claim by telephone who send a claim form to the insured for completion and return. To satisfy the claim notification condition the insured should return this within a reasonable time.

112 113


Typical questions on a property claim form and their reason for insurers asking them include:

Name, address and policy number - enables insurers to locate the underwriting fileDate of Loss - to check it occurred during the period of insuranceCause of Loss – to ascertain if the peril is insuredDetails of damaged property – to check that the policy insures itInsured’s relationship to the property – check on policy cover and insurable interestValue of the property – to check the sum insured and for averageCost of repairs or replacement – the basis of the insured’s claimDetails of any other party involved – checking for possible recovery through subrogationOther insurances – to check for double insurance

A liability claim form will ask for details of the incident and extent of injuries or property damage to third party as a guide to the size of the claim expected.

On receipt of a claim form the claims official will make a number of checks before proceeding. Typically these are:• That there are no outstanding premiums• Loss date is within the period of insurance• Name, address, occupation, previous claims, and other information

agree with the underwriting file• Cause of loss is an insured peril• There is no breach of a warranty or condition• That the sum insured (for property insurance) is adequate• The amount claimed is reasonableIn the event of doubt of any issue, further enquiries may be necessary.

Some claims dispense with the need for a claim form. Large losses where loss adjusters are carrying out a detailed investigation make a claim form unnecessary.

What action would you recommend if the information on the underwriting file contradicts the information on the claim form?

114 115


5.5 - Renewal Invitations

The majority of policies run for 12 months. There is no obligation on either side to renew but insurers are keen to keep good business and want the insured to renew the contract for a further 12 months.

The insurer will issue a renewal notice just before the renewal date (three to four weeks is a typical period), which brings to the insured’s attention that the period of insurance is ending and indicating the renewal premium required. There is no obligation to issue a renewal notice but it is clearly in insurer’s interests if they wish to retain the business.

The renewal notice will indicate the premium required by insurers to continue the insurance for a further 12 months. It will contain brief details of the insurance, policy number and possibly where and how to pay. The renewal notice may also contain a warning or reminder to the insured of the duty of utmost good faith and that he must notify any changes or alterations to the risk.

The new period of insurance is a new contract albeit at the same terms and conditions as the expiring contract.

What effect does the renewal, being a new contract, have on the insured’s duty of utmost good faith?

Days of GraceMany insurers will insist that they receive the renewal premium before the renewal date. If there is non-payment then the implication is that the insured does not want to renew the insurance and the policy will lapse.

There are cases however when the insured has not paid the premium by the due date but it is their intention to renew. The renewal notice may have been lost, the insured on holiday when it arrived, the cheque for payment may be mislaid. To allow for this insurers may allow a period of time, (7 to 14 days is typical but could be 30 days) known as days of grace during which if the premium is paid the policy will continue without any break in cover.

114 115


Days of grace do not apply if the insured indicates that it is not their intention to renew. Neither are they on extension of cover.

The Finance Director of a company returns from vacation on 5th September and discovers the renewal notice for the company’s public liability on his desk. The renewal date was 1st September and he immediately prepares a cheque and sends it to insurance company by messenger. Several weeks later, a customer makes a claim against the company alleging injuries received in a showroom on 3rd September two days before the premium was paid. Do you think insurers will deal with claim? Give reasons for your answer.

Long-Term AgreementsLong-term agreements are agreements between the insured and insurer whereby the insured agrees to offer the risk for insurance to the insurer for a stated number of years (three is typical) at the same terms and conditions in force at expiry. In return, insurers offer a discount from the premium (5% or even 10%).

Insurers do not have to accept the offer and if they revise the terms and conditions of the insurance, this becomes a counter offer and the insured does not have to accept the new terms. It helps insurers to retain business especially on a large commercial contract where the expenses of surveying and policy preparation are in the first year.

Both sides benefit from a long-term agreement, the insured from the reduction in premium and the insurer retains the business.

Long-term agreements are not long-term contracts, each contract is for 12 months and the agreement is simply that insurers have an opportunity to retain business while their terms remain unchanged.

116 117



1. Why do insurance companies use proposal forms?a. To determine the deductableb. To calculate the premiumc. To get the material factsd. To put the conditions

2. What information is in the preamble?a. The exclusionsb. The coveragec. Proposal; is basis of contractd. The warranties

3. What information is in the operative clause?a. The exclusionsb. The coveragec. Proposal; is basis of contractd. The warranties

4. Why do insurance policies need conditions?a. To set the rules for insured and insurance companyb. To control bad moral hazardc. To keep good aspects of riskd. To control morale hazards

5. Generally what is more serious?a. breach of warranty b. breach of conditionc. both are correctd. both are wrong

116 117


6. When do insurers use endorsements?a. If there is a physical hazardb. To control moral hazardc. To eliminate morale hazardd. If there is any change in the policy

7. Why do insurers issue renewal notices?a. To maintain policyholdersb. To get new policyholdersc. If there is any change in the policyd. Evidence for cover

8. Days of grace.a. A period with no coverb. There is cover although premium is not paidc. There is intent to renew and coverage but premium is not receivedd. Is obligatory for an insurance company to give to all policy holders

Module 6:Regulation of the Insurance Industry in the Kingdom


- Understand why the insurance and protection savings industry needs to be regulated- Understand the role of SAMA- Understand article two of the regulations

IntroductionNational economies vary from free market, open economies to state controlled nationalised economies. However, even in the freest of free market economies governments find it necessary to control and regulate their insurance industry.

Insurance companies are entrusted with huge amounts of money - in the $50 Billion to $200 Billion range in the case of the largest U.S. life insurance companies, such as the Prudential Insurance Company of America, Metropolitan Life Insurance Company and New York Life Insurance Company. The insurers are thus custodians of public funds and they have to be regulated in an effort to ensure that the public and its funds are dealt with honestly and also to prevent the insurers from taking unwarranted risks in the name of investments with the money they are holding.

120 121


The Purpose of Regulation

The primary purposes of insurance regulation historically have been: (1) To maintain the insurers’ financial solvency and soundness so they can

carry out their long term obligations to policyholders and pay claims.(2) To guarantee a fair treatment of current and prospective policyholders

and beneficiaries by both insurers and the people who sell their policies.

(3) The need to make certain types of insurance compulsory as a way of achieving broad financial protection to the general population.

In this section, we start with a look at the background to the introduction of regulation in the Kingdom of Saudi Arabia, why government controls are necessary, why some classes of insurance are compulsory, and how these issues are dealt with in the Kingdom. 6.1 - Why the insurance industry needs to be regulated?

Consumers buy insurance to protect themselves against what is generally a small probability of a catastrophic loss, effectively transferring the risk of any loss to an insurance company. In turn, the insurance company spreads the risk it assumes over a large pool of policyholders, using capital reserves to shoulder any compensation costs to policyholders who may incur an unexpected loss.

Concepts of insurance dates back to 3000 B.C. There are several examples of pre-Islamic history whereby families, tribes or related members throughout the Arabian Peninsula pooled their resources as a means to help the needy on a voluntary and gratuitous basis. These practices were validated by Prophet Mohammad (Peace Be Upon Him) and incorporated into the institutions of the early Islamic State in Arabia around 650 AD.

Examples of these early Islamic practices include the following: • Merchants of Mecca formed funds

to assist victims of natural disasters or hazards of trade journeys.

• Surety called “daman khatar al-tariq” was placed on traders against losses suffered during a journey due to hazards on trade routes.

120 121


• Assistance was provided to captives and the families of murder victims through a grouping known as a’qila.

• Contracts, called “aqd muwalat”, were entered into for bringing about an end to mutual amity or revenge.

• Confederation was brought about by means of a “hilf ”, or an agreement for mutual assistance among people.

However, it was during 1500’s to 1700’s, when more modern types of policies began to develop for life, marine and fire insurance

The roots of Lloyds’s of London began at Lloyd’s Coffee in 1688, where shippers and merchants would negotiate and obtain insurance on shipping fleets and their cargo.

During the period of the British colonisation and trade with U.S. colonies, some insurers cooperatively agreed to set reserves, in order to maintain solvency and build public trust and confidence. This was the first major step towards regulation, although it initially was self-regulation. Early government regulation included reporting requirements, taxes on insurers, and granting charters.

Later, in the 1800s, as rapid urbanisation and industrialisation took place across Europe and America, many governments established regulations to set standards and guard against problems of insolvency, after a number of catastrophic fires led to insurance bankruptcies. Regulations also were used to discourage opportunistic and financially unsound companies.

Throughout this period, governments and their regulators became anxious about insurance policy rates that were either too high or too low. The regulators wanted to keep the industry competitive but also balanced. If markets and prices were too competitive, regulators believed that low rates could be predatory and would lead to a decreased number of insurance companies, many failing due to bankruptcy. In such cases policyholders would suffer as there would be insufficient funds available to pay for policyholders’ losses. On the other hand, if rates were too high insurance companies would be seen as price-gouging by not offering affordable rates to the masses which could lead to the public avoiding insurance which, in turn, could impact the public well-being. During this time period, regulators also started to become concerned with preventing price discrimination.

122 123


The period following World War II through to the end of the 20th Century saw increasing and more sophistication of regulation in the insurance and financial sector as a whole. Largely driven by the need for consumer protection regulation encompasses many aspects of the industry, from robust financial requirements of insurers and reinsurers to codes of conduct for agents and brokers.

Some economists have criticised regulation by pointing out that efficiently working markets are the best means for consumers to get what they want at the lowest price and highest quality. While this may be true, regulations have been shown to be necessary in order to protect consumers, correct market imperfections and be a backstop for preventing a variety of harms caused to consumers. Regulations can help consumers by providing recourse for common problems and complaints, helping industries institute universal standards and guidelines, and, most importantly, increasing consumer welfare.

“Competition can be depended on to keep rates from being excessive, and good management will keep them from being inadequate; regulation of insurance rates is an infringement on the right of management to make business decisions.”

Do you agree or disagree with this statement? Why?

6.2 - The Historical Background of the Insurance Industry in the Kingdom

The Control of Cooperative Insurance Companies Regulation, which was enacted as Royal Decree No M/32 on 1 August 2003, is the first Saudi Arabian legislation regulating insurance. While in recent years over 75 insurance operators were writing business estimated in excess of SAR 2.7 billion in the Kingdom, they were able to do so without virtually any regulation at all. Now, this has been completely transformed. What used to be an unregulated, free-for-all has become one of the most closely regulated insurance markets in the region.

122 123


124 125


The past lack of regulation does not mean that the Saudi Arabian government took a non-interventionist approach to the insurance industry. Rather, its past reluctance to legislate in relation to insurance arose from the uncertain status of insurance under Sharia’h Law. While, for example, the prohibition of charging or paying interest is based on clear statements in the primary sources of Islamic Law, there is no reference to insurance in the Islamic Law texts which are regarded as authoritative in Saudi Arabia. This is not surprising, since these texts were compiled in the period from the 13th to 17th centuries of the Gregorian calendar, that is, at a time when insurance was just evolving as a business in Europe.

In Saudi Arabia, the debate of whether or not contracts of insurance are legitimate under Sharia’h law was narrowed down to the key issue that to profit from an insurance transaction runs counter to Islamic law, while collective risk sharing is acceptable and in the community’s interest. This is based on Decision No 51 of 23 March 1977 of the Supreme Council of the Senior Ulema, a Saudi Arabian government body of religious scholars, who ruled that cooperative (or mutual) insurance is “a form of contract of donation”, and, because no one is supposed to profit from cooperative insurance transactions, the Senior Ulema considered insurance in this form to be acceptable under Islamic Law.

In 1985, the state-owned National Company for Cooperative Insurance (NCCI) - which is now named TAWUNIA - was formed by Royal Decree as a Saudi Arabian joint stock company, with the Public Investment Fund, the Pension Fund and the General Organization for Social Insurance as its shareholders. This was done in response to the Senior Ulema’s recommendations that a cooperative insurance company should be established in the Kingdom of Saudi Arabia to offer an alternative to commercial insurance.

In keeping with NCCI’s articles of association, the company maintains separate accounts for both its policyholders and for its shareholders. Therefore, it is actually a hybrid between a true mutual insurer, which is wholly owned by its policyholders and not traded on a stock market, and a commercial insurer, but nevertheless sufficiently mutual to meet the Senior Ulema’s recommendation that it should conduct its business on a cooperative basis.

124 125


Although there was never a statutory prohibition of commercial insurance in the Kingdom, the Saudi Arabian Ministry of Commerce did not issue commercial registrations to any person or company, other than NCCI, to conduct insurance business in the country. Yet, a fair number of foreign-registered insurance organisations operated in Saudi Arabia. The majority of these were Bahraini-exempt companies, that is, companies registered in Bahrain with the express purpose of not conducting business there. The companies’ day-to-day business in Saudi Arabia, such as writing policies and settling claims, was done through a local agent. In other words, the majority of insurance operators in Saudi Arabia were foreign-based but marketing and underwriting risks within the Kingdom.

13 ptIn accordance with the strict letter of the law, conducting any kind of business in Saudi Arabia without holding the requisite commercial registration is unlawful. Notwithstanding this, the Ministry of Commerce exercised a loose supervisory function over foreign insurers who conducted business in the country, and there certainly was nothing clandestine in the manner in which those organisations operated.

For example, all government construction contracts contain a proviso that the contractor must have Contractor’s All-Risks Insurance with an insurer who is represented in Saudi Arabia, and it was quite acceptable to insure such risks with Bahrain-based, Saudi-operating insurers other than NCCI. Despite this pragmatic approach to a predicament created by an interpretation of the Islamic law principles, which are relevant in this context, having an insurance industry which is essentially offshore and not subject to strict supervision naturally created problems.

While a handful of the foreign insurers who wrote business in Saudi Arabia were of a blue-chip background, there were many who were financially unsound and sometimes unscrupulous. Not surprisingly, there were incidents of insurers collecting premiums and disappearing overnight. Furthermore, because the business was essentially foreign, local retention of risk and reinsurance within the Saudi market was low, with over 70 per cent of the premiums generated in Saudi Arabia leaving the country. Nevertheless, until quite recently, no serious effort was made to impose real control on the Kingdom’s insurance market. The current reforms were driven by two important changes that were taking place within the Kingdom.

126 127


As insurance was an unrecognised business in the Kingdom, how did insurers get around the problem to enable them to write business in Saudi Arabia?

The main reasons for allowing and regulating insurance are:1. The medical compulsory Insurance.2. Joining the World Trade Organization.

For many years, all health-care in Saudi Arabia has been free to citizens and foreign residents alike. Since there are an estimated six million foreign workers and their dependents in Saudi Arabia, this clearly imposes a considerable burden on the nation’s healthcare system and on the economy as a whole. To alleviate the problem, the government introduced the Cooperative Health Insurance Act, Royal Decree No M/10 of 13th August 1999, which makes it mandatory for employers to take out private medical insurance for their foreign employees and their dependents.

In principle, the government could have just made private health insurance for foreigners obligatory and left the Saudi insurance market in its existing, disorganised state. However, the Regulation requires that insurers providing cover under the scheme must be Saudi-registered cooperative insurance companies. Because there was only one entity which fulfils this requirement, namely the NCCI, the effect of the legislation could have been the introduction of a state-owned monopoly. However, the expansion of state-owned industry is not in line with the overall government policy. Rather, the Saudi government has been working to encourage an increase in the private sector’s role in the economy as a whole not to decrease it. Additionally, setting up the provision of health insurance to an estimated four to six million persons within a relatively short period would have been a logistical exercise well beyond the capacity of any single entity.

126 127


The second key driver to the introduction of insurance regulation in the Kingdom was King Abdullah’s determination to have Saudi Arabia accede to the World Trade Organization (WTO). A part of the Kingdom’s agreement to join the WTO was the opening up of its insurance sector to foreign interests. In truth, this is a paradox, because in its past unregulated state the Saudi insurance market was open to all comers, albeit not in any official basis. If one viewed the opening up of the Saudi insurance market solely from the perspective of being able to establish a licensed Saudi Arabian insurer, it was closed to both foreigners and Saudis alike, since there was no framework for the setting up of such entities, other than NCCI, of course.

World Trade Organization website: www.wto.org

So, the Control of Cooperative Insurance Companies Regulation came into force on 20th November 2003. With the issue of the Implementing Rules on 23rd April 2004, a new industry in the Kingdom was born. 6.3 - Regulation of Insurance in the Kingdom of Saudi Arabia

Recall from the previous section, when the decision was made for Saudi Arabia to open its doors to insurance it was done so on the basis of the improving the consumers’ welfare, it being in the public interest, to enable the nation to deal with its healthcare insurance problem, and also to bring about an open market, fairness and a level-playing field between foreign and domestic insurance companies in line with WTO agreements.

On 30th of July 2003, the Saudi Council of Ministers passed historic legislation opening the Kingdom’s insurance sector to foreign investment and the Control of Cooperative Insurance Companies Law came into force on 20 November 2003. However, the issuance of the Implementing Rules, which were meant to be published on 21 October 2003, was delayed until 23 April 2004. Therefore, because much of the detail of the legislation is contained in the Implementing Rules, the new regulatory scheme did not become effective until 23 April 2004.

128 129


The objective of the law and the implementing Regulations we expressed in the Article two of the Regulations:

‘Article Two’Objectives of the law and its implementing Regulations1. Protection of policy holder and shareholders 2. Encouraging fair and effective competition 3. Enhancing the stability of the insurance market 4. Enhancing the insurance sector in the Kingdom and provide training

and employment opportunity to Saudi nationals.’

The government regulator of the Saudi insurance sector is the Saudi Arabian Monetary Agency (SAMA), which, since its formation in 1957, has proven to be a successful and stringent regulator of the Saudi banking sector. Indeed, SAMA has brought this young nation’s monetary system well within modern standards.

SAMA website: www.sama.gov.sa

With respect to insurance, SAMA’s duties and powers are wide-ranging. They include the preparation of the Implementing Rules of the Regulation, licensing of insurers wishing to operate in Saudi Arabia, and, generally, policing and control of the Saudi insurance sector. This also includes insurance brokers, insurance agents, insurance consultants, surveyors, loss adjusters and actuaries, all of whom must now apply to SAMA for a licence to carry on business in Saudi Arabia. When viewed broadly, SAMA’s insurance regulatory powers in the Kingdom includes the following: 1. Regulations for the establishment of insurance and reinsurance

companies in the Kingdom;2. The supervision of the technical aspects of insurance and reinsurance

companies’ operations;3. Regulation of the distribution of surplus funds to shareholders and

policyholders;4. Determining the capital and solvency requirements for each class of

insurance business required by companies;5. Regulation of the companies’ investments both inside and outside of

the Kingdom;6. Actuarial and rating approval.

128 129


7. Education and qualification requirements of insurance company personnel, brokers and agents.

8. Content of policy forms.9. Code of Conduct, insurance sales and information disclosure.10.Contract interpretation and enforcement.11.Compulsory purchase of insurance coverage.

Now let’s look at each of these regulatory areas in more detail and with specific reference to the Kingdom’s legislation.

1. Regulations for the establishment of insurance and reinsurance companies in the Kingdom

The Regulation restricts insurance activities in the Kingdom to Saudi-registered companies which are incorporated by Royal Decree as public joint stock companies, with a minimum paid-up capital of SAR100 million for primary insurers, and SAR200 million for reinsurers. Applications for licences must be lodged with SAMA, which, if the application is approved, refers the matter to the Ministry of Commerce and Industry for the formalities of incorporation in accordance with the Saudi Arabian Companies Regulation.

Licensing Requirements – Insurance and Reinsurance Companies

Before licensing, the prospective insurer or reinsurer must complete an application and submit it to SAMA for review. The application package should include the following:1) Completed licensing application2) Memorandum of Association3) Articles of Association 4) Organisational structure5) Feasibility study6) Five-year business plan which must include as a minimum:

i) Classes of insurance that will be undertaken by the Company. ii) Ability to cede or accept reinsurance treaties for classes the

Company intends to insure.

130 131


iii) Marketing plan. iv) Projected costs and financing to start the Company’s operation. v) Projected underwriting growth taking into consideration solvency

margin requirements. vi) Expected number of employees and a Saudisation plan for training

and employment. vii) Annual costs based on projected growth rate. viii) Projected financial statement related to the growth rate. ix) Technical Provisions statement for the proposed growth of the

insurance operation certified by a qualified actuary. x) Branch distribution plan in the Kingdom.

7) Any agreements with outside parties.8) An irrevocable bank guarantee issued by a local bank for the capital

required (Such a guarantee must be renewed until the capital is paid up.)9) A non-refundable application fee of SR 10,000 for Companies.

Licensing Requirements – Individual Insurance Professions

The regulations identify specific insurance professions requiring licensing. These include: • Actuaries• Insurance agents• Insurance Brokers• Insurance Consultants and Advisors• Claims or loss assessors, adjusters and claims settlement specialists• Key Company personnel dealing with and advising the public.

130 131


These professionals must meet the following requirements:1) A university degree as a minimum, and five years relevant insurance

experience, or an insurance professional designation acceptable to SAMA.

2) Pass the examination approved by the SAMA to engage in the qualification acceptable to SAMA.

Once the application has been received SAMA will advise the applicant within 30 business days confirming the application is complete or further information is required. When the application is complete, SAMA will advise the applicant of its decision within 90 business days. Upon approval of the license a licensing fee is required:

Insurance Companies SR 100,000Reinsurance Companies SR 200,000Insurance and Reinsurance Companies SR 300,000Insurance and Reinsurance Providers (Except Actuaries and Insurance Advisors)

SR 25,000

Actuaries and Insurance Advisors SR 5,000

The regulations also aim to ensure that companies involved in the provision of insurance and reinsurance services, other than insurers and reinsurers, are financially sound. As a result minimum capitalisation requirements for these companies are required. In addition, to ensure that the public and other industry members are protected, insurance and reinsurance services providers have to obtain a professional liability policy covering liability risks for negligence, wrongdoing and dereliction of duties.

132 133


The minimum requirements for capitalisation and professional liability insurance cover are given in the following table:

Type of Insurance Service Provider

Minimum capitalisation Requirement

Minimum Professional Liability Cover

Reinsurance Brokerage SR 3,000,000 SR 6,000,000Insurance Brokerage SR 3,000,000 SR 3,000,000

Claims Settlement Specialists (Third Party

Administrator)SR 3,000,000 SR 1,000,000

Insurance Agency SR 500,000 SR 1,000,000

Loss Assessors and Loss Adjusting

SR 500,000 SR 3,000,000

Insurance Advisor SR 150,000 SR 500,000

Actuary SR 150,000 SR 6,000,000

2. The supervision of the technical aspects of insurance and reinsurance companies’ operations

As well as fairly strict licensing conditions on companies and individuals, the regulations place high, but not unreasonable, capitalisation requirements on companies wishing to operate within the Kingdom’s insurance sector. It is quite likely that these stringent requirements will lead to a large-scale exodus of insurers from the Saudi Arabian market, leaving a few well-structured and highly regulated insurance companies. Certainly, this is the intention of the regulations. Because the legislation requires insurers to be incorporated as public joint stock companies, the Kingdom will see a fair number of new companies coming onto the stock market (IPOs) within a relatively short period.

Foreign OwnershipThere are no restrictions on foreign participation in insurance companies registered under the new framework. However, full foreign ownership of a Saudi insurance company is at present precluded, because under the current regulations publicly traded stock may not be owned by non-Saudi interests. Therefore, at present, foreign interests can only participate in a Saudi insurance company as founding shareholders.

132 133


Neither the Regulation nor the Implementing Rules specify how much of an insurance company’s stock must be floated, but Saudi Arabian banks with foreign shareholders, which operate under similar principles, have between 30 and 40 per cent of their stock traded publicly, and there have been indications that the requirement in respect of insurance companies will be 25 per cent.

Classes of Insurance Insurers must be licensed by SAMA to write specific classes of business, which are broadly grouped as general insurance (including accident, liability, motor, property, marine, aviation, energy and engineering), health insurance, and protection and savings insurance, or for two or more of these, depending on the proposals put forward by the applicant in the feasibility study and business plan, which must be submitted with the licence application. Once a company is duly licensed, the offering of any products in the market must be pre-approved by SAMA.

Valuation of Investments, Assets and Technical ProvisionsAs far as finances are concerned, the Implementing Rules contain detailed provisions governing investments, solvency margins, evaluation of assets and technical provisions. Saudi insurers are required to maintain 50 per cent of their assets in Saudi Riyals, although this may be reduced with SAMA’s prior approval. Saudi insurers may not invest more than 20 per cent of their assets outside of Saudi Arabia. Certain types of investments, for example those in derivatives, require pre-approval of SAMA. A company is required to have written investment and risk assessment guidelines approved by its board.

Transnational TransactionsUnder the terms of the Implementing Rules several restrictions are imposed on transnational transactions. Thus SAMA’s approval must be obtained before a Saudi insurer associates with non-Saudi insurance funds. Saudi insurers, brokers and agents who wish to place cover with Lloyd’s or non-Saudi insurance companies must obtain SAMA’s permission. At least 30 per cent of cover must be reinsured within the Kingdom, although this percentage may be reduced with SAMA’s consent.

134 135


Reinsurance regulationsThe Implementing Rules set out detailed guidelines relating reinsurance and are particularly specific regarding the use of non-Saudi reinsurers with who cover may be placed. Certainly, dealing with a reinsurance (or insurance) company not licensed in the Kingdom will not be tolerated and heavy fines will be imposed. Consumer protection is naturally the main reason for such stringent rules. An insurer that engages treaties outside the Kingdom must adhere to the following criteria:1) The foreign reinsurer is licensed to transact the type of reinsurance

proposed in the Kingdom in its own country of domicile.2) The insurance regulator of the foreign reinsurer must authorise the

exchange of relevant information with SAMA.3) The foreign reinsurer must maintain separate records and financial

statements of all Saudi operations and these must be made available to SAMA upon request.

4) The insurance company must provide SAMA with the reinsurer’s latest financial statements and the latest regulatory report issued by the reinsurer’s insurance regulatory authority.

5) The insurance company must select a reinsurer with a minimum S&P (Standard and Poors) rating of BBB (or equivalent internationally acceptable rating).

In addition, whether the reinsurance agreements are with foreign based or Saudi based reinsurers, all reinsurance agreements must be filed with SAMA.

Technical ProvisionsNaturally, the Technical Provisions must be calculated in accordance with generally accepted accounting standards and approved by the actuary. When reporting, the following technical provisions must be included as a minimum:1) Unearned premium reserve2) Unpaid claims reserve3) Incurred but not reported (IBNR) claims reserve4) Unexpired risk reserves5) Catastrophe risk reserves6) General Expense reserve7) Reserves related to Protection and Savings insurance, such as disability,

old age, health, death, medical expenses, etc.

134 135


The reserves must be calculated in a specified manner as approved by the regulations.

3. Regulation of the distribution of surplus funds to shareholders and policyholders

A key aspect of the introduction of regulated insurance in the Kingdom is the cooperative nature of the industry. Therefore the regulations require that Saudi insurers must operate on this cooperative basis. As a model for what constitutes cooperative insurance, the Regulation has pointed to NCCI’s articles of association, which insurance companies registered in the Kingdom are supposed to use as a blueprint for their articles of association.

The key to the distribution of surplus funds lies in how the net surplus is calculated. This calculation is made in the following steps:

Step 1) Determine the Earned Premiums, and income generated from reinsurance commissions and other insurance operations.

Step 2) Determine the Incurred Indemnification.Step 3) At the end of each year calculate the Total Surplus representing

the difference between Step 1 and Step 2, less any marketing, administrative expenses, the necessary technical provisions, and other general operating expenses.

Step 4) The Net Surplus is then calculated by taking the Total Surplus and adding or subtracting the policyholders’ investment return, and subtracting the general expenses related to the management of the policyholders’ investment funds.

Step 5) Once the Net Surplus has been calculated 10% of the net surplus is to be distributed to the policyholders directly either in the form of a direct payment or as reduction in premium for the next year.

136 137


The remaining 90% of the Net Surplus is to be transferred to the shareholders income statements. Twenty percent (20%) of the net shareholders’ income is to be set aside as a statutory reserve until reserve amounts are equal to 100% of the paid capital.

In addition to these rules, SAMA must approve the Company’s calculations and net surplus distribution and timing.

4. Determining the capital and solvency requirements for each class of insurance business required by companies

Solvency is the minimum standard of financial health for an insurance or reinsurance company, where assets exceed liabilities. For the protection of policyholders and the assurance of stability within the marketplace, regulators, such as SAMA, are particularly concerned about monitoring company solvency.

Statutory DepositsInitially, each company must make a Statutory Deposit of 10% of the paid up capital. If SAMA believes there to be a greater than normal risk with the company or the type of business it is participating in, then it may request a statutory deposit of up to 15%. The deposit must be made within 3 months of the company’s license being issued, in a bank designated by SAMA.

10%

20%

70%

Policy Holders

Reserve

Stock Holders

136 137


Asset Valuation and Solvency MarginsThe principal assets of general insurers tend to be: (1) The loss reserves. (2) The unearned premium reserves.(3) Investments. For companies involved in the Protection and Savings area of insurance, the assets are primarily accounted for by the policy reserves, which is the insurer’s obligation to policyholder for the policyholders’ savings and expected policy payments. The much lower capital-to-assets ratio for protection and savings companies than general insurers (6% to 35%) reflects the differences in the risk for the products that the two groups sell. Variability of claims costs are much lower for protections/savings (and health and life insurers) than they are for general insurers. As a result, the regulations require a much smaller cushion (or amount of capital per Riyal of assets) needed to avoid the probability of insolvency for the protection/savings industry.

Additionally, within general insurance the riskiness of business can vary considerably. In view of the risk differences between general insurers and protection and savings companies, the assets of each class of business must be considered separately.

The assets that can be included in the solvency calculation must be related to the business of insurance. For example, if a company has issued bonds or has assets obtained from loans, then these cannot be included as they have non-insurance related liabilities attached to them. The regulations provide a table of acceptable assets and the conditions to their valuation.

Also, the Regulations demand that companies that fall below their required solvency margins notify SAMA immediately and agree upon a plan with SAMA to restore the margins to their approved levels within the next financial quarter. If the margins fall significantly and the company has not been able to restore them to the acceptable levels then SAMA will require the company to do some or all of the following:a. Increase the Company’s capital,b. Adjust their insurance premiums,c. Reduce costs,d. Stop underwriting business,e. Asset liquidation.

138 139


Furthermore, SAMA may enforce other actions and may appoint an advisor to provide private consultation and advice to the company or even order a cease and desist order to stop the company underwriting business. SAMA can also withdraw the company’s license if the solvency margin falls below 25% or the company fails to rectify its solvency problem.

5. Regulation of the companies’ investments both inside and outside of the Kingdom

As insurance companies are tasked with the stewardship of their policyholders’ money, either for savings and investment or for ensuring funds are available to cover their policyholders’ losses, it is important that these funds are managed prudently. To help ensure wise investment management the regulations demand that the insurance and reinsurance companies invest these funds wisely.

Each company must have a clear, written investment policy governing the investment policy and methods of managing their investment portfolios. At least 50% of the company’s investments must be invested in Saudi Riyals. And the investment policy must include a diversification strategy, which gives consideration to the risks faced by the company and the environment in which it operates. Risk management of the investments is critical and the investment diversification plan should, at a minimum, include consideration of the following:

Risks:a. Market riskb. Credit riskc. Interest rate riskd. Currency exchange riske. Liquidity riskf. Operations riskg. Country riskh. Regulatory and legal riski. Reinsurance riskj. Technology risk

138 139


Within the regulations, SAMA has provided a set of investment standards which the companies must work within. These set the limits of the types of investment and their concentration. Specifically, companies are not permitted to use financial instruments such as derivatives and off-balance-sheet items, other than for efficient portfolio management and only with SAMA’s approval.

6. Actuarial and rating approval.The regulations require that each company appoint an Actuary who holds that designation of ‘Fellow’, or contracts the services of an actuarial firm with the permission of SAMA.

The actuary or actuarial firm plays an important role in maintaining the company’s sound financial position. Indeed, the regulations provide an outline to the duties of the actuary:a. Obtain all required previous information from the previous actuary.b. Examine the Company’s financial position.c. Evaluate the Company’s ability to meet its future obligations.d. Determine adequate risk retention levels.e. Price the Company’s insurance products.f. Determine and approve the Company’s technical provisions.g. Provide advice and recommendations related to the Company’s

investment policy.h. Any other actuarial recommendations as he or she sees fit.

As a qualified professional, the Actuary is deemed to be professionally liable for his/her advice and technical services provided to the Company. The actuary is viewed by the regulations as the pivotal individual for the supply of financial and technical information to SAMA.

7. Education and qualification requirements of insurance company personnel, brokers and agents.

The regulator, SAMA, also oversees the education and qualifications of all insurance industry professionals.

140 141


The Institute of Banking (IOB) is currently the education and training arm of SAMA. The IOB has already been very successful in developing professional education programs for the financial services industry in the areas of banking, investment, banking operations and English language. The IOB also, currently manages insurance exams for the Chartered Insurance Institute and the Bahrain Insurance Institute. Currently, the IOB is developing a program for training and education in conjunction with SAMA and the major insurance companies.

IOB website: www.iobf.org

Ultimately, however, the regulations place the responsibility of ensuring that insurance employees are trained, educated and qualified by the companies themselves.

Also, related to this is the requirement within the regulations that the percentage of Saudi employees be at least 30% at the end of the first year of the company’s operation and that this percentage be increased annually according to the Saudisation plan submitted to SAMA.

8. Content of policy forms.The regulations have not specified the use of a standard form of policy for each class of insurance as is often done in other jurisdictions. However, the regulator, SAMA, must approve all of the policy wordings used by each insurer and reinsurers. In addition, the company must adhere to minimum coverage levels as agreed with SAMA for each class of business.

Naturally policies must be written in such a way that they are clear and unambiguous and can be read by the public at large. In line with conventional policy documentation the policy schedules must contain, at a minimum, the following:a. The policy number, which must also be provided in all related

documents,b. Policyholder’s name and address,c. The period of cover,d. Description of coverage and limits,e. Deductibles and retentions,f. Endorsements, warranties and riders,

140 141


g. Conditions and exclusionsh. The insurance rates, premium amounts, the basis of premium

calculation and the amount of commission paid to a broker or agent.i. Clear identification of the property or activities being insured.

In addition, the standard text of the policy must contain the types of coverage, general terms, conditions and exclusions. The endorsements and riders must indicate any additional coverage, conditions and exclusions, identifying where they change the main agreement. Also, in line with convention, the company’s seal and signature must be printed on the policy and attachments.

9. Code of Conduct, insurance sales and information disclosureConsumer protection and the development of consumer confidence in the insurance industry are critical to the spirit of the regulations. Therefore, it is no surprise that the regulations have several Articles which direct companies on how they should relate to policyholders to ensure clarity and eliminate any misunderstandings regarding the policy coverage and premium.

Communication with PolicyholdersIf they wish it, policyholders must be allowed to view the policy terms, conditions and exclusions, before agreeing to the insurance contract. Once the policy is issued the contract cannot be changed by the company unless there is a material change in the risk. Policyholders can amend the policy by written request and, if agreed, this must be followed by an addendum issued by the company.

Cancellation, Denying and Non-Renewal of a policy

The company cannot cancel insurance during the policy period unless for a reason specified in the cancellation clause of the policy. If the company does cancel a policy it must refund any pre-paid premium on a pro-rata basis and the policyholder must be given at least 30 days written notice before the effective date of the cancellation. The company must also advise the policyholder the reason for the cancellation of the policy. If the policyholder cancels the policy before it expires then the company may refund any pre-paid premium on a ‘short period-rate’ basis.

142 143


The insurance must be issued without discrimination and unfair treatment. For example, an insurance company cannot deny insurance to a person of a certain race due to the colour of his or her skin. Neither can insurers deny coverage to a person or company solely because of the decisions of other companies. Acceptance and denial of insurance can only be made on the basis of the risk and the activities surrounding the risk itself. This would, however, include the loss history of the risk and/or policyholder. The same factors apply to cancelling or non-renewing a policy. The insurer must have credible reasons for cancelling, denying or non-renewing insurance.

Utmost Good FaithThe term utmost good faith is a key principle of insurance and the regulations apply the principle of utmost good faith. In other words, insurance contracts require that both the company and the policyholder disclose all relevant information to each other. This principle requires policyholders to respond truthfully to whatever questions the insurance company asks. Also, the policyholder must disclose any relevant information to the insurer about the risk or activities to be insured, even if the insurer does not directly ask the question. Likewise, the insurance company must disclose the policy wording, terms, condition and exclusions to the policyholder before the contract is issued. This must include a description of the basis of indemnification of the policyholder in the event of a loss.

10. Contract interpretation and enforcement.While it is the duty of each company to interpret the policy and settle claims in line with standard insurance conventions, the regulations require companies to show evidence of fairness and adhere to minimum standards for claims settlement.

Each company must have its own claims department with procedures for accepting, evaluating and processing claims. The company must maintain records of each claim, whether they are paid, unpaid or rejected.

The regulations require that each company settle individual policyholders’ claims within 15 days of receiving all requested necessary documentation related to the claim. If the case warrants an extension of an additional 15 days may be provided by the regulator. For commercial policyholders’ claims the settlement must be made within 45 days. If this period is exceeded, the regulator must be advised and provided with reasons for the delay.

142 143


Companies must respond to policyholders’ complaints within 15 days. All complaints must be registered and their outcome documented. A semi-annual report must be prepared and provided to the regulator.

11. Compulsory purchase of insurance coverage.The Insurance Implementation Regulations do not cover the administration of compulsory insurance purchasing, such as automobile insurance. However, as compulsory insurance tends to be a legal requirement, in the case of automobile insurance, health insurance and social insurance it is worth a short discussion.

Governments in a free market economy try not to interfere in the workings of the market place. The basic rules of supply and demand and a competitive environment are generally sufficient to ensure good order. However, almost every government finds it necessary to intervene in the insurance market place and make some types of insurance compulsory.

Failing to insure when it is compulsory will result in a criminal offence and punishment. Typically, a fine, which should be large enough to deter people from avoiding buying insurance and ultimately a prison sentence, is possible.

In society, there is a general principle that the innocent victims of accidents should be able to receive compensation from the guilty or negligent party who caused those injuries. It is often to support this principle that governments make some classes of insurance compulsory.

Compulsory insurance assist innocent victims to receive compensation in three broad areas:

FundsIf a person causes injury to another, the injured party can seek compensation from the guilty party and states have legal systems in place to aid this process. This process is defeated however, if the guilty party has no funds (‘a man of straw’) or hides his funds. Governments feel it necessary therefore to make insurance compulsory in certain cases as a means of ensuring that there will be funds available to compensate the innocent victim of accidents.

144 145


Society’s Duty In the event that no financial compensation is available the consequences can be severe for the victim and his family. In case of death or disablement to the family ‘breadwinner’, the family may have to rely on other family members or charity for support. If these are not available or inadequate, society through their government has a duty to look after its people. Insurance will provide the necessary financial compensation and reduce the burden on family or society.

Public DemandsIn some cases there are issues that the public consider unjust, because victims are denied access to financial compensation. Insurance is a method to help justice by ensuring that such compensation is available.

Recently, the Kingdom of Saudi Arabia made automobile insurance (third party liability) and medical expenses insurance compulsory for all drivers and residents/citizens. Why do you think the government made these types of insurance obligatory?Do you think that the reasons fit in to the above categories or are there other reasons?

Automobile InsuranceIn KSA, third party motor insurance has been compulsory since November 2002. Originally, the requirement was everyone who holds a driving licence to have Rukhsa insurance providing unlimited indemnity for death or bodily injury to a third party and a minimum SR5M indemnity for third party property damage. Rukhsa insurance is linked to the driver. However, this was changed in 2006, when Rukhsa insurance was replaced with the conventional automobile insurance based on the vehicle at risk.

144 145


Health/Medical InsuranceIn most countries, the government is involved in providing healthcare in some form or another. It may be supervising or nationalising health insurance or the means of providing healthcare.

If health insurance is compulsory then the government, private insurance companies or a combination of private and public, may provide it. The UK has a different approach, as the government owns hospitals and provide healthcare to citizens free at the point of delivery. The government, who raise the revenue through taxation and national insurance contributions pay doctors and other health service workers. Private hospitals are available for those who are willing to pay the extra costs.

In the Kingdom of Saudi Arabia, the government requires that all residents have medical expenses insurance. From September 2002, it became mandatory for expatriates to have private medical insurance.

Injuries at Work Unfortunately, accidents at work are a very common source of injuries and could result in a great deal of litigation. To ensure that workers are protected many governments around the world have made compulsory, one or both of the following systems in place: a workers’ compensation plan and/or an employer’s liability insurance contract.

Workers’ compensation usually involves the government providing a schedule of benefits that it is compulsory for the employer to pay in the event of injury to an employee during the course of his employment. Sometimes, the Workers’ Compensation plan is run by the government similar to a state-run insurance company and sometimes it is merely a supervisor of the law. Generally, in these plans, liability is not an issue as it is a ‘no fault’ system i.e. it is not necessary to prove fault, it is sufficient to show that the injury occurred at work.

Compensation is the amount detailed in a schedule of benefits, typically wages during any period of incapacity and possibly a lump sum for certain injuries. The employer can take out an insurance policy to indemnify him for his liability under any workmen’s compensation rules.

Under an employer’s liability system, (used in the UK) there is no guarantee of benefits. An employee must prove liability i.e. that the employer is responsible for any injury or illness. If successful, the employee can claim any amount considered appropriate. It is compulsory for the employer to have an insurance policy, with an approved insurer to ensure that funds are available to meet any award. It is worth mentioning that the courts have shown that they consider the employer’s responsibility to be very wide.

In Saudi Arabia, GOSI regulations cover injuries at work. They provide compensation according to a scale of benefits considered adequate to meet the basic requirements of an average labourer. An employer may need workers’ compensation insurance to cover work related injuries repudiated by, or in excess of GOSI. If the GOSI benefits are inadequate for an employee perhaps, with a large family or additional responsibilities the employee may take legal action for additional compensation. Employers in KSA may therefore also require full employer’s liability insurance to give them this extra protection.

Other Compulsory InsurancesMotor vehicle accidents, injuries at work and healthcare are areas that most countries have legislation but governments often require insurance as part of a licensing or authorising process for particular professions. Examples include:• Legal and medical professions• Insurance brokers• Keepers of dangerous animals (zoos, circuses)• Riding Schools• Funfairs and Amusement Parks

Insurance is also a requirement for many contracts, which effectively makes insurance compulsory for the contracting party. In the Kingdom, for example, government contracts will normally stipulate that the contractor must have a minimum insurance arrangement with their approved insurer. Most banks will require insurance to be placed on a house if they are financing the purchase of the home with a mortgage loan. They may also, require that the buyer has life insurance to ensure that the loan can be paid off if he or she dies unexpectedly.

146 147


SummaryThe three main reasons for insurance regulation are: (1) To maintain the insurers’ financial solvency and soundness so they

can carry out their long term obligations to policyholders and pay claims.

(2) To guarantee the fair treatment of current and prospective policyholders and beneficiaries by both insurers and the people who sell their policies.

(3) The need to make certain types of insurance compulsory as a way of achieving broad financial protection to the general population.

In the Kingdom, the current Insurance Regulations were on 1 August 2003. This brought an end to the previously unregulated industry that was largely based outside of the country. The introduction of the new regulations was largely driven by two factors: the introduction of compulsory private health insurance for foreign residents, and as a part of the agreements for Saudi Arabia to accede to the World Trade Organisation (WTO).

The Insurance Implementation Regulations do not cover the administration of compulsory insurance purchasing such as automobile insurance. However, other laws require the purchase of insurance such as automobile insurance, health insurance and social insurance.

146 147



1. The insurance sector requires government regulation in order to:a. protect policy holders.b. protect insurance companies.c. protect brokers.d. encourage fair competition between insurance companies.

2. The landmark decision that led opening the Kingdom’s insurance sector to foreign investment was in:

a. 1977b. 1999c. 2002d. 2003

3. What is the key difference between a Sharia’h recognised Cooperative insurance company and a typical commercial insurance company?

a. Cooperative distributes profits to policyholders onlyb. Cooperative distributes profits to shareholders onlyc. Cooperative distributes profits to policyholders and shareholdersd. Commercial distributes profits to policyholders only

4. What were the two key drivers that brought about the introduction of insurance as a regulated industry within the Kingdom?

a. Motor insurance and personal accidentb. Contactors all risk and medical malpracticec. Marine and joining gulf uniond. Medical and joining the WTO

5. Which government agency is responsible for regulating insurance in the Kingdom of Saudi Arabia?

a. The Capital Market Authority.b. The Ministry of Banking, Finance and Insurance.c. The Institute of Banking.d. The Saudi Arabian Monetary Agency.

148 149


148 149


6. Match each type of Insurance business with the minimum required professional liability limits:

a. Insurance Brokerage 1. SAR 6,000,000b. Actuary 2. SAR 3,000,000c. Insurance Agency 3. SAR 1,000,000

a. a1; b2; c3b. a2; b1; c3c. a3; b2; c1d. a2; b3; c1

7. Under the Law on Supervision of Co-operative Insurance Companies, which one of the following statements is true?

a. Insurance companies must be 100% wholly owned by Saudis with the entire net surplus being accounted for as Retained Earnings and / or returned to the shareholders as dividends.

b. All insurance companies must be “co-operative”, which means that the company is totally owned by the policyholders with the entire net surplus being returned to the policyholders as dividends and/or kept in the company as Retained Earnings.

c. There are no restrictions on the ownership structure of insurance companies operating in Saudi Arabia as this would conflict with World Trade Organisation agreements.

d. Foreign owned companies must trade at least 30% of their stock on the Saudi Arabia stock market.

8. How much of the Net Surplus is paid to policyholders?a. 10%b. 20%c. 70%d. 100% 9. An Insurance Company, in respect to its general and health insurance

business, shall maintain a margin of solvency equivalent to:a. The Premium Solvency Marginb. The Claims Solvency Marginc. The Minimum Capital Requirementd. The highest of a), b), or c)

Module 7:Market Code of Conduct Regulation (MCCR)


- Define MCCR - Identify what sectors of the insurance market MCCR is applied- Understand the minimum standards required by MCCR

IntroductionInsurance contract is nothing but a piece of paper which promises to pay in the event of an insured contingency actually happens.

So in every country there will be regulations in place to protect the customer against deficiency in service in terms of delayed issuance or poor quality of documentation as well as non payment, delayed payment or short payment of claims.

Saudi Arabian Monetary Agency, the Insurance regulator for the Kingdom of Saudi Arabia has introduced Market Code of Conduct Regulation (throughout this courseware, we will refer to this regulation as MCCR) which will not only regulate marketing and selling of insurance products but also stipulates codes for insurers and service providers for a fair and transparent conduct of business and dealing with the customers.

152 153


Why is MCCR an integral part of any insurance market?

7.1 - Introduction to MCCR

The code stipulates minimum standards that should be met by the insurance companies and the service providers.

It may, sometimes, so happen that the insurance company’s internal standard for customer service may be more stringent than the minimum standard set by SAMA in this Regulation. Any Regulator will welcome such a move as this only goes towards improving service delivered to the customer and enhancing customer delight.

The following are the Service Providers who come under the scope of MCCR Insurance Brokers, Insurance Agencies, Claim Settlement Specialists, Loss Assessors/Adjusters, Insurance Advisors, Third Party Administrators

In the above list of Service Providers, one service provider in the insurance value chain is missing. Can you name them? Why MCCR is not applicable to them?

Since Customer Service depends entirely on how efficiently the company is organised to deliver that service, it is necessary that they establish appropriate internal checks and controls and put in place systems and procedures to not only ensure delivering excellent customer service but also monitor the delivery as well.

Systems and procedures will also mean that companies maintain adequate records like premium register, cover note control register, certificate register, claim intimation and settlement registers etc so that at any point of time, information can be retrieved for appropriate customer service.

152 153


Since the service providers like loss adjusters and third party administrators represent an insurance company and act as face of that company while dealing with the public, in case of any deficiency in service on the part of service providers, the credibility of the insurance company who the service provider is representing will be affected. So the insurance company will have to ensure that the service providers have necessary controls and systems in place for efficient delivery of customer service on their behalf.

7.2 - General Requirements

Integrity: Though it is expected that the companies will generally act in a fair and transparent manner in all their dealings with the customer, Regulator and the general public, the MCCR has codified this in the form of general requirement.

The companies and the service providers are required to have an internal document which sets out the systems and procedures for conducting and transacting the business in a fair and transparent manner. Wherever, such steps and procedures are not codified, they have to adopt internationally accepted best practices for conduct of business.

What is the purpose behind codifying steps in conducting the business in a fair and transparent manner?

Skill, Care and Diligence: In order to provide efficient customer service, the companies should have necessary technical skills and competence.

Competence has to be developed through periodic training in technical subjects, customer service and also regularly updating the employees through internal communication of the happenings in the Market in KSA and the world over.

154 155


It is the duty of a company to keep the employees’ skills and insurance knowledge up-to-date? Discuss the ways in which a company can do that.

MCCR expects all customers to be treated alike and no company can deny renewing or cancel an insurance policy without giving a valid reason for doing so.

Protecting customers’ personal data is very important and companies should ensure that such data is not allowed to be abused or misused.

What are the ways in which personal data can be protected?

Any premium collected by the brokers or the agent must be immediately deposited with the insurance company.

Can you think of two specific reasons why the premium should be deposited with the insurance company immediately?

The brokers/agents can also the deposit the premium in the bank account specifically for this purpose and should not appropriate this money for any other purpose.

The only exception for the above rule is that they can withdraw their commission from this account but only after getting the necessary authorisation from the Insurer in writing to this effect.

154 155


Can the broker/agent treat the money in the premium account as security against any sums receivable from the Insured?

Since the service providers like brokers, agents, loss adjusters, TPAs etc represent the company and deal with the customers on behalf of the company, it is essential that the insurance company enters into a contract with these service providers setting out the procedures, rights and responsibilities of each party and also the establishment of systems controls for effective delivery of service by these providers to the customers on their behalf.

7.3 - Conduct Standards

To ensure that the customers are not put to difficulty, MCCR insists that the insurance policy application and contract wordings must adhere to some minimum standards.

MCCR lists of the following as minimum standards:1. The proposal form and the policy document must be bilingual –

both in Arabic and English. 2. The sentence structure and the language used should be simple and

should be easily understandable by laymen.3. They should be printed in clear readable text.4. There is also a mention about the legendary small print in insurance

policies and MCCR specifically prohibits these documents to be in fine print.

Further guidelines:MCCR also provides further guidelines as regards the proposal form and the policy document.The policy form must contain:1. A disclosure statement indicating that the policy contract is the entire

contract2. A description of Insured’s duties after a loss has occurred3. A description of claims and disputes handling procedures.

156 157


Any amendment to the policy should be done only after receiving a written request for the same from the Insured and also these amendments should be made only by way of endorsement.

Policy Cancellation:Another requirement of MCCR is that cancellation of insurance policies should be made simple and that the terms must be fair to the customer.

Every policy must contain cancellation terms which will includea. conditions under which the Insurer has the right to cancel the policyb. conditions under which an Insured can cancel the policyc. Notice period required for cancellation by both the partiesd. The method of refunding the premium , if applicable on cancellation

ande. A description of cash surrender value, if applicable (in case of

Protection & Savings insurance)

Free Look Clause:

A FREE LOOK clause has to be incorporated in all Protection & Savings which should provide a minimum of 21 days period from the date of delivery of the policy to the Insured.

Free Look period is the right of an Insured to examine an insurance policy for a stated period, in this case 21 days, and if the Insured is not satisfied of its suitability and benefits to him, to return the policy and receive a refund of the initial premium.

In some markets, the refund is in full whereas, in the Kingdom, the regulator has stipulated that a pro-rated amount will be retained by the Insurer for the period for which they had assumed risk after deducting the expenses incurred by them on medical examination.

In case of Unit Linked Plans, the Insurer is also entitled to make appropriate adjustments to take the changes in the price of the Units into consideration.

156 157


Discuss the issues associated with 100 % refund of premium under Free Look Clause

Advertising and Promotion:Companies should use their advertising campaign judiciously and should not communicate inaccurate statements about the company, products, price, coverage, benefit etc.

Defamatory statements about competition:They should not also target their competitors in their advertising campaign.

Information on companies’ offering:The companies must disclose some minimum pre-acceptance information to the customers:1. Whether they are Insurers or intermediaries2. Whether there exists any other relationship between the Insurer and

the intermediary other than the brokerage/commission 3. The nature and range of products and services they can offer.

Information from/to the customers:Companies are obliged to seek information from customers to assess their insurance needs depending on the products and services which they are interested.

Since insurance contracts are based on the duty of utmost good faith, Insurers should draw the attention of the customers to their duty to disclose relevant and accurate information.

Companies have to take care that the advice given to clients adequately meets their needs. They should provide sufficient information to enable customers to make informed decisions when purchasing insurance products and services.

158 159


Churning:Companies should inform the Insured of the consequences when he wants to replace the existing P & S insurance with a new one.

Obligation of brokers:

The brokers are Insured’s representative and hence have to get the best possible term for their clients. They do this by obtaining quotes from several insurance companies.

When they obtain such quotes and recommend one, they have to indicate the reasons for recommending any particular insurance company. The justification should include a comparison of the terms and conditions offered by each insurance company, and if the broker would earn more commission on the recommended contract this must be explained to the customer.

Obligation of Insurers:The first step before accepting a business from the proposer is to provide the important terms and conditions of the product in which the proposer is interested.

Some of the key information required to be furnished to the proposer includes:1. Benefits, exclusions, and deductibles.2. The coverage period.3. All related costs, including premiums and any other fees.4. The terms of payment covering the periodicity of payment, grace

period, implications of discontinuing the premium and any other related details.

5. The claims and complaints handling procedure.6. The obligations of each party under the insurance policy.7. The cancellation and renewal rights and conditions.8. The requirements for carrying out policy alterations.9. Any aspect of the policy where the insurance company has the right

to change something once cover has commenced such as benefit charges and policy fees on protection and savings business.

10.Any unusual restriction or condition attaching to the customer.

158 159


Which principle of insurance casts the above obligations on the part of the Insurer? How?

In addition to the above, companies must provide the following information withregard to protection and savings insurance products:1. Type of plan – Participating, non participating or investment linked.2. Basis of participation in profit in case of participating – cash bonus,

deferred bonus, reversionary bonus, terminal bonus etc.3. Plan illustration providing the sum insured, surrender value and paid

up value over the term of the plan.

Insurance cover should not be back-dated on any insurance product. Why?

Confirmation of coverage:It is the duty of the Insurer to provide written confirmation confirming the coverage as soon as a contract is concluded.

What are the ways in which a written confirmation can be given evidencing the contract?

When an application for insurance is taken without a premium payment, the Insurer should provide a receipt to the customer indicating that coverage will commence at the date the policy is issued and the first premium is paid.

Insurers are obliged to provide the full policy documentation to customers after entering into an insurance contract promptly.

160 161


It is mandatory on the part of the Insurers to obtain the customers’ signature confirming the contents, understanding, and receipt of the full policy documentation.

How does a counter signature from the customer help?

Policy coverage to employees and close relatives:Insurers should avoid covering the assets and liabilities of their employees which will include the owner, Board of Directors, management and staff including their close family members. In case, this requires to be done, then the full premium needs to be collected before the cover commences.

Close family members will mean wi(fe)ves, children, parents, brothers and sisters.

Premium Collection:Insurers can collect premium on a transaction only if it is finalised.

Insurance companies are considered to have received the premiums once the premiums are received by the agents or brokers.

The agent of an Insurer collected the premium cheque and posted it to the company. While the cheque was in transit, a claim occurred. Is the insurance contract is valid and the claim payable?

160 161


Claims handling:Whether the Insurer handles claims directly or through outsourcing, the following are some of the activities which are expected of them/handling agency:A. Respond to claims filing in a prompt manner.B. Provide claims forms showing all the information or steps required

by the customer (including the beneficiary under a protection and savings policy) to file the claim.

C. Acknowledge to the customer the receipt of the claim and any missing information and documents within ten (10) days from receiving the claim’s application form.

D. Provide adequate guidance to the customer in filing the claim and information on the claims handling process.

E. Inform customers of the progress of filed claims, at least every fifteen (15) working days (as per article 44 of the Implementing Regulations).

F. Handle claims in a fair manner.G. Appoint a claims or loss adjuster when necessary, and notify the

customer of such an appointment within three (3) working days.H. Conduct a reasonable investigation of claims within a reasonable

time period.I. Notify the customer in writing of the claim acceptance or refusal

promptly after completing the investigation, stating the following: 1. For accepted claims (full or partial acceptance): - Settlement amount. - How the settlement amount was reached. - Justification if reduced settlement is offered. - Justification in case any part the claim is not accepted.

2. For denied claims: - Written reason for denying the claim under question. - Copies of documents or information that were used in reaching the decision, if requested.

J. Explain the appeal or complaints process, if the settlement is not accepted by the customer.

K. Forward the claims settlement payment without undue delay upon receiving all required information and documentation.

162 163


Insurance companies are obliged to settle the claims within fifteen days from the date of receiving all requested and necessary documents and when that is not possible, provide an explanation, with reason(s) for such delay.

Credit ControlFull payment terms must be agreed in writing at the outset of the policy, and the insurance company should promptly cancel a policy, after appropriate warnings, and thirty (30) days notice, if payments are not made. Premiums must be paid separately from, and may not be offset from, claims payments.

Complaints HandlingComplaints handling and resolution are important constituents of after saes service.

Companies have to put in place a fair, transparent, and accessible complaints handling process, and inform customers of the complaints filing procedures.

CancellationCancellation of policies must conform to the cancellation conditions specified in the policy terms and conditions.

Cancellations by the insurance company must be notified to customers in writing, including a reference to the relevant contractual cancellation condition and explanation of the underlying reasons for the cancellation. In such cases, the balance premium has to be returned on pro-rated basis.

The policyholder may also cancel the policy in which case he will be entitled for a refund on short period scale as per the schedule given in the policy.

Can the insurance company cancel a policy where a valid claim has occurred?

162 163


Renewal and ExpiryCompanies must inform customers of the policy renewal or expiry date in a timely manner to allow customers to arrange continuing insurance coverage.

For all protection and savings contracts, insurance companies should provide an annual statement to their customers which include the following information:

A. Projected maturity value, or value at age eighty-five (85) for the whole policy.

B. Current sum insured on main and supplementary benefits.C. Total premiums paid in the previous year.D. Policies linked to investment funds should show the value of the

units in each fund.

Distribution of Surplus:A key aspect of the introduction of regulated insurance in the Kingdom is the cooperative nature of the industry. Therefore the regulations require that Saudi Insurers must operate on this cooperative basis. One of the main points which distinguish cooperative insurance from a traditional insurance model is the distribution of surplus funds to the policyholders.

The key to the distribution of surplus funds lies in how the net surplus is calculated.

This calculation is made in the following steps: Step1: Earned Premium + income generated from reinsurance

commissions and other insurance operations.Step2: Incurred Claims = (claims outstanding at the end of the year +

claims paid – Claims outstanding at the beginning of the year)Step3: Total Surplus = (Difference between Step 1 and 2) – Marketing

expenses – Administrative expenses – technical provision – general operating expenses

Step4: Net Surplus = Step 3 (+/-) Policyholder’s investment return – expenses relating to management of policyholder’s investment fund

10% of the net surplus is to be distributed to the policyholders directly either in the form of a direct payment or as reduction in premium for the next year

164 165


The remaining 90% of the Net Surplus is to be transferred to the shareholders income statements.

Twenty percent (20%) of the net shareholders’ income is to be set aside as a statutory reserve until reserve amounts are equal to 100% of the paid capital.

Insurers have to document the mechanism they have to put in place to comply with article seventy (70) of the Implementing Regulations, and submit this document to SAMA for approval.

This document should then be freely available to customers and Members of the Public.

7.4 Appendix

Draft dated 05.01.2008 of the Market Code of Conduct Regulation to be implemented by Insurers and Insurance Service Providers in the Kingdom of Saudi Arabia – introduced by Saudi Arabian Monetary Agency (English version)

164 165


Part 1Introduction

Purpose1. This Code presents the general principles and minimum standards

that should be met by insurance companies, including branches of foreign insurance companies, and insurance service providers licensed by SAMA in their dealings with their existing and potential customers.

2. The objective of This Code is to promote high standards of business conduct within the insurance industry.

3. This Code must be read in conjunction with articles 12, 15, 16, 19, 22, 24, 25, 26, 37, 43, 44, 45, 46, 49, 51, 52, 53, 54, 55, 56, 71, 77, 78, and 80 of the insurance Implementing Regulations.

Definitions4. The terms used in This Code shall have the same meaning as per

article one (1) of the insurance Implementing Regulations, unless mentioned otherwise.

Scope and Exemptions5. The term “Companies” in This Code is intended to include: insurance

companies, insurance brokerages, insurance agencies, insurance claims settlement specialists, loss assessors (loss adjusters), and insurance advisors.

6. Reinsurance activities are exempted from the provisions of This Code.

Compliance Measures7. Companies must establish appropriate internal controls and

procedures to ensure and monitor compliance with This Code, including the compliance of all contracted companies.

8. Companies must maintain adequate records to demonstrate compliance with This Code, including but not limited to, reasons for early termination or non-renewal of insurance policies, claims records and complaints records.

166 167


Supervision of Other Contracted Companies9. Insurance companies are responsible for ensuring that all persons

dealing with customers on their behalf, including their own staff and other licensed agents who sell the company’s products and services, perform their duties in compliance with this Code.

Non-Compliance10. Non-compliance with the requirements set forth in This Code will

be deemed a breach of the licensing conditions and may subject the companies to enforcement action.

11. Companies should promptly inform SAMA of any circumstances that may restrict their ability to adhere to the requirements herein.

Structure of This Code12. The market conduct requirements are outlined in Parts 2 and 3 of

this Code:A. Part 2 -General Requirements, which are principle-based. B. Part 3 - Conduct Standards, which stipulate the companies’ minimum

conduct requirements across the customer relationship lifecycle, which includes pre-sales, sale, and post-sale conduct guidelines.

Part 2General Requirements

Integrity13. Companies must act in an honest, transparent and fair manner, and fulfill all of their obligations to customers, which they have under the laws, regulations, and SAMA guidelines. Where these obligations have not been fully codified, companies may follow internationally accepted best practices.

Skill, Care, and Diligence14. Companies must act within their area of competence in dealing

with customers. For this purpose, competence is acquired through training, experience, and working with experts in the field.

15. It is the duty of each company to keep their, and their employees’, skills and knowledge of the insurance business upto-date and be informed of the products and services offered by the company, or companies, they represent and the intended use of these products and services.

166 167


Non-Discrimination16. Companies must not unfairly discriminate between customers,

whether existing or potential customers, and must provide credible reasons for denying, canceling, and not renewing insurance policies.

Adequate Resources17. Companies must take reasonable care in maintaining adequate

managerial, financial, operational, and human resources to carry out their business and serve their customers.

Disclosure Information to Customers18. Companies must communicate all relevant information to

customers in a timely manner to enable them to make informed decisions.

19. Companies must take reasonable measures to ensure the accuracy and clarity of the information provided to customers and make such information available in writing.

Data Protection20. Companies must, at all times, ensure that customer personal data

is protected. This means that the data: A. Must be obtained and used only for specified and lawful

purposes. B. Must be kept secure and up to date. C. Must be provided to the customer upon his written request. D. Must not be disclosed to any third party, without prior

authorization from SAMA, other than the companies’ auditors and actuaries.

Security of Customer Assets21. Companies must ensure the security of customers’ assets held on

their behalf. Any premiums collected by the broker or agent must either be placed in a separate bank account (the premium account) that has been established for that purpose, or passed directly to the insurance company as is required under the contractual arrangement with the insurance company. The only payments that can be deducted from the premium account are:

A. Premium payments to a licensed insurance company.

168 169


B. Commission payments where the insurance company authorizes the broker or agent to make premium payments net of commission. The premium account must not be treated as the property of the broker or agent in any sense. In particular, it must not be used as security for any loan, and it must be clearly beyond the reach of the broker or agent’s creditors.

Conflict of Interest22. Companies should take reasonable measures to identify and address

conflicts of interests to ensure fair treatment to all customers. Where conflicts of interest arise, the companies must disclose such conflicts to the customer and must not unfairly place its interests above those of its customer.

Contracting Service Providers23. Companies that use the services of other parties, including other

companies, must have a contract in place setting out the terms and conditions for the provision of services, the rights and responsibilities of each party and the extent of the liability that each party has to the other.

Part 3Conduct Standards Section A: Policy Forms and Rates

Policy Wording and Packaging24. The wording of the insurance policy application and contract

forms must adhere, at a minimum, to the following: A. Written in both Arabic and English. B. Use simple language and sentence structure, when possible. C. Printed in clear, readable text, with no fine print.25. The printed insurance policy application and contract forms

must adhere to requirements set in article 52 of the Implementing Regulations, and include:

A. A disclosure statement indicating that the policy contract is the entire contract.

B. A description of the insured’s duties after a loss has been incurred.

C. A description of the claims handling and dispute handling procedures.

168 169


Policy Amendments26. An insurance policy contract shall be amended only after a written

request submitted by the policyholder and to which the insurance company agrees followed by an endorsement issued by the insurance company to the policyholder.

Policy Cancellation27. Companies should include cancellation terms that are fair to

customers and are reasonable and appropriate with regard to the product. The cancellation conditions must be clearly stated in the policy contract, including:

A. Conditions permitting the insurance company to cancel the policy.

B. Conditions permitting the policyholder to cancel the policy. C. Cancellation notice requirements, including notice period. In

any case, the Policyholder should be afforded a minimum period of thirty (30) days before the effective date of cancellation by the companies (as per article 54 of the Implementing Regulations).

D. A description of the refund of premium due to the policyholder on cancellation of the policy and when it would be payable.

E. For Protection and Savings insurance, in addition to (D) above, a description and illustration of the cash surrender value, if applicable, for each year of the plan.

“Free Look” Clause(Protection & Savings Insurance Products)28. Every policy for protection and savings insurance should provide

at least a twenty-one (21) day Free Look period from the date of delivery of the insurance contract for the policyholder to review the contract to assess its suitability and whether it provides the benefits described by the agent or broker. The policy will be deemed to be fully in force and this provision will be deemed to be waived by the policyholder, if the policyholder does not inform the insurance company within the period that the policy will be returned. If the policyholder deems the policy unsuitable, the insurance company must be notified in writing within the Free Look period and a refund of premiums paid to the customer subject only to the following:

A. Deduction of the expenses incurred by the insurance company on medical examination of the customer.

B. Deduction of a proportionate risk premium for the period of cover.

170 171


C. In respect of a unit linked plan, the insurance company shall also be entitled to make an appropriate adjustment to take account of changes in the unit price.

Pricing29. Companies must apply the pricing structure submitted to and

approved by SAMA as part of the product approval application.

Discrimination30. Companies’ underwriting criteria and practices must not be unfairly

discriminatory.

Section B: Advertising and PromotionHonest Representation31. Companies must not communicate any statements or advertising,

directly or indirectly, that are inaccurate, misleading, exaggerated, or deceptive, including but not limited to information on:

A. Name of the company issuing the insurance policy. B. Financial status of the insurance company issuing the policy. C. Coverage of the policy. D. Benefits or advantages promised by the policy. E. If the advertising includes the policy pricing, then it should

indicate whether the price is inclusive of all fees.

Defamatory Statements32. Companies should not include in their advertising any false or

defamatory statements on other companies.

Section C: Pre-sale Customer ContactInformation about the Companies’ Offering33. Companies must disclose, at a minimum, the following information

to each customer prior to accepting an application for an insurance contract:

A. Whether they are an insurance company, or are acting on behalf of an insurance company, or acting on behalf of the customer.

B. Any financial relationship between a broker and the insurance company other than the normal commission agreements. In particular if there is any cross-ownership, or both parties have owners in common, the customer should be informed.

170 171


172 173


C. The nature and range of products and services they can provide.

Customer Needs Assessment34. Companies must seek information from customers as might

reasonably be expected to assess their insurance needs in relation to the products and services in which they indicated an interest. Companies are not required to determine customers’ insurance needs beyond the specific products and services in which customers have indicated an interest, except with regard to protection and savings contracts (see article 41 below).

35. Customers should be informed of their duty to disclose relevant and accurate information.

Advice to Customers36. Companies must ensure that the advice given to clients adequately

meets their needs.37. Companies must provide sufficient information to enable

customers to make informed decisions when purchasing insurance products and services, including:

A. An explanation of how the proposed advice meets their needs. B. If different options are identified, the difference in the benefits,

coverage, and costs of such options.

Avoidance of Churning38. Companies should not advise a customer to replace an existing

protection and savings policy with a new one, unless it fully justifies the recommendation and make it clear that a second set of initial charges will be incurred, and the agent will earn initial commissions on the new product.

Quotations to be Obtained from More than One Insurance Company39. Insurance brokers must make reasonable efforts to obtain

quotations from several licensed insurance companies, and indicate the reasons for recommending any particular insurance company. For contracts other than protection and savings, if the insurance company recommended by the broker has not provided the cheapest quotation, the broker must provide details of the cheapest quotation

172 173


to the customer, and a full justification for his recommendation. The justification should include a comparison of the terms and conditions offered by each insurance company, and if the broker would earn more commission on the recommended contract this must be explained to the customer.

Section D: Sale of Insurance Products and ServicesDisclosure to Customers40. Prior to accepting an application for an insurance contract,

the companies must provide customers with the key terms and conditions of the product and service to be purchased, including but not limited to:

A. The name of the insurance company underwriting the policy. B. Benefits, exclusions, and deductibles. C. The coverage period. D. All related costs, including premiums and any other fees. E. The terms of payment covering the periodicity of payment,

grace period, implications of discontinuing the premium and any other related details.

F. The claims handling procedure. G. The complaints handling procedures. H. The obligations of each party under the insurance policy. I. The cancellation rights and conditions. J. The renewal rights and conditions. K. The requirements for carrying out policy alterations. L. Any aspect of the policy where the insurance company has the

right to change something once cover has commenced such as benefit charges and policy fees on protection and savings business.

M. Any unusual restriction or condition attaching to the customer. N. The postal address, telephone, fax and email contact details of

the insurance company.41. In addition to the above, companies must provide the following

information with regard to protection and savings insurance products:

A. Whether the plan is participating, non-participating or an investment linked plan.

B. In case of participating, the basis of participation in profits i.e., cash bonus, deferred bonus, reversionary bonus, terminal bonus etc.

C. Plan illustration providing the sum insured, surrender value and paid-up value over the term of the plan. The illustration should show these values at the end of each of the first five (5) policy years, five (5) yearly thereafter, and at maturity date if appropriate or up to age eighty-five (85) if not.

D. If benefits are not fully guaranteed, the customer should be provided with three illustrations with gross investment return rates of 3%, 5% and 7% p.a.

E. The extent of any investment or expense guarantees. It should be clearly stated that values shown are for illustrative purposes only unless the investment and expense charges are fully guaranteed.

F. For non-linked plans, where applicable, a breakdown of the premiums and charges by main cover, supplementary cover and any other cover or services provided.

G. When presenting information related to past performance, the basis on which the performance was calculated together with a statement that past performance is not indicative of future performance.

H. If the policyholders’ funds may be invested in a range of linked investment funds, a description of the investment funds, which should include, at a minimum:

1. A description of the asset classes the fund may invest in. 2. A risk or volatility rating for each fund. 3. If the fund is measured against a benchmark, details of that

benchmark. 4. Geographical spread of the investments. 5. A statement of any concentration of investments into particular

types of investments. 6. The currency that the fund is priced in. 7. The frequency that the fund is priced. 8. The name of the fund manager, if the fund is external to the

insurance company. 9. Past performance of the fund, subject to the same comments as

stated in (g) above.42. Companies selling savings and protection contracts should

complete a client fact find containing sufficient information to fully back-up the product recommendation made. The fact find must be signed by the client, and retained on the clients file. In the event of any dispute over the appropriateness of the contract sold, the

174 175


contents of the fact find will be taken fully into account. If the fact find is not on the file, or is poorly or partially completed, this is likely to lead to the dispute being resolved in favor of the client.

43. Insurance brokers should disclose to the customer at the point of sale the full commissions and/or fees earned for the services provided from all sources.

44. Companies that represent the insurance company in arranging the insurance contract must disclose to the customer all commissions, fees, and any other remuneration received from arranging the insurance contract.

45. Insurance cover may not be back-dated on any insurance product. No insurance company, or employee of an insurance company may provide evidence of cover on a product unless the customer has committed to taking out a full annual policy that complies with the minimum standards set for that policy.

Customer Obligations46. Prior to entering into an insurance contract, the companies must

inform customers of their key obligations under the insurance contract to pay premiums in a timely manner and to provide full and honest disclosure of all relevant information needed to determine the insurance needs and underwrite the risk. The customer should only be expected to advise the companies of information that a reasonable person would regard to be relevant.

Confirmation of Coverage47. Upon entering into an insurance contract, companies must

promptly provide customers with official written confirmation of the insurance coverage. In case the full documentations are not available, the companies must issue temporary evidence of coverage confirmation, which can be legally used as a proof of coverage.

48. When an application for a compulsory insurance product such as motor or health is taken with a premium payment, a receipt should be provided to the customer indicating that coverage commences at the date the application was completed.

49. When an application for insurance is taken without a premium payment, a receipt should be provided to the customer indicating that coverage will commence at the date the policy is issued and the first premium is paid.

174 175


Documentation50. Companies must promptly provide the full policy documentation

to customers after entering into an insurance contract. Companies must obtain the customers’ signature confirming their revision, understanding, and receipt of the full policy documentation.

Related Parties51. No insurance policy shall be issued or renewed by an insurance

company to any of its owners or members of the Board of Directors, Senior and Executive Managers, and their related parties except after the payment of the full premium (as per article 49 of the Implementing Regulations). Related parties shall be taken to mean close family members, wives, husbands, children, parents, brothers and sisters.

Premium Collection52. Companies must not collect premiums or fees for transactions that are

not in the process of being provided or have not yet been provided.53. Insurance companies are considered to have received the premiums

once the premiums are received by the agents or brokers.

Section E: Post-sale Customer ServicingAfter-Sale Service54. Companies must provide after sales services to customers in a

timely and appropriate manner, including responding to their inquiries, administrative requests, and requests for amending the insurance policies. In particular, companies must:

A. Provide certificates of coverage when requested by the customer.

B. Provide written confirmation of any amendments to the policy and any additional amounts due.

C. Issue receipts for any amounts received, unless payment is made by credit card or other form of automated bank transfer when the bank records will suffice.

D. Issue refunds or other charges due to customers. 55. Companies must promptly notify customers of any changes in the

disclosures or conditions made to the customers at the time of entering into the insurance contract. This includes changes in the companies’ contact details and changes in the claims filing procedure.

176 177


Claims Handling56. For companies whose licensed activities include claims handling,

they must: A. Respond to claims filing in a prompt manner. B. Provide claims forms showing all the information or steps required

by the customer (including the beneficiary under a protection and savings policy) to file the claim.

C. Acknowledge to the customer the receipt of the claim and any missing information and documents within ten (10) days from receiving the claim’s application form.

D. Provide adequate guidance to the customer in filing the claim and information on the claims handling process.

E. Inform customers of the progress of filed claims, at least every fifteen (15) working days (as per article 44 of the Implementing Regulations).

F. Handle claims in a fair manner. G. Appoint a claims or loss adjuster when necessary, and notify the

customer of such an appointment within three (3) working days. H. Conduct a reasonable investigation of claims within a reasonable

time period. I. Notify the customer in writing of the claim acceptance or refusal

promptly after completing the investigation, stating the following: 1. For accepted claims (full or partial acceptance): - Settlement amount. - How the settlement amount was reached. - Justification if reduced settlement is offered. - Justification in case any part the claim is not accepted. 2. For denied claims: - Written reason for denying the claim under question. - Copies of documents or information that were used in

reaching the decision, if requested. J. Explain the appeal or complaints process, if the settlement is not

accepted by the customer. K. Forward the claims settlement payment without undue delay

upon receiving all required information and documentation.

Claims Settlement57. Insurance companies must settle claims within the time period

indicated in article 44 of the Implementing Regulations, and when that is not possible, provide an explanation, with reason(s) for such delay.

176 177


Credit Control58. Companies may not provide excessive credit to customers. Full

payment terms must be agreed in writing at the outset of the policy, and the insurance company should promptly cancel a policy, after appropriate warnings, and thirty (30) days notice, if payments are not made. Premiums must be paid separately from, and may not be offset from, claims payments.

Complaints Handling59. Companies must put in place a fair, transparent, and accessible

complaints handling process, and inform customers of the complaints filing procedures.

60. Upon receiving a complaint, companies must carryout the following:

A. Acknowledge the receipt of the complaint. B. Provide an estimate of the time to address the complaint. C. Provide the customer with the contact reference to follow up on

the filed complaint. D. Inform customers on the progress of the filed complaint. E. Address the claims in a prompt and fair manner within ten (10)

working days of receiving the complaint. F. Notify the customer, in writing, whether the complaint is

accepted or rejected, and the underlying reasons for the decision and, if applicable, any offered compensation.

G. Explain the dispute filing process to escalate the complaint to the committees established by article 20 of the law on supervision of cooperative insurance companies.

Cancellation61. Cancellation of policies must conform to the cancellation

conditions specified in the policy terms and conditions. Cancellations by the insurance company must be notified to customers in writing, including a reference to the relevant contractual cancellation condition and explanation of the underlying reasons for the cancellation.

178 179


178 179


62. Amounts due to customers as a result of the cancellation of a policy must be paid without undue delay, and must be calculated in accordance with the provisions of article 54 of the Implementing Regulations.

Renewal and Expiry63. Companies must inform customers of the policy renewal or expiry

date in a timely manner to allow customers to arrange continuing insurance coverage.

64. For all protection and savings contracts, insurance companies should provide an annual statement to their customers which includes the following information:

A. Projected maturity value, or value at age eighty-five (85) for the whole policy.

B. Current sum insured on main and supplementary benefits. C. Total premiums paid in the previous year. D. Policies linked to investment funds should show the value of the

units in each fund.

Distribution of Surplus65. An insurance company must document the mechanism it will put

in place to comply with article 70 of the Implementing Regulations, and submit this document to SAMA for approval. This document should then be freely available to customers and Members of the Public.

Progress Check Answers

182 183


Module 1

1-a2-c3-a4-b5-d6-c7-c8-a9-b10-a11-b12-d13-a14-b15-a16-c

Module 2

1-c2-c3-d4-c5-d6-a7-d8-c9-a

182 183


10-b11-d12-d13-c14-c15-c16-b17-b18-c19-c

Module 31-d2-d3-b4-b5-b6-a7-c8-b9-d

Module 41-a2-c3-b4-d5-a6-c7-d8-a9-c

Module 51-c2-c3-b4-a5-a6-d7-a8-c

Module 61-a2-d3-c4-d5-d6-b7-c8-a9-d

184
